What Is Negative Gearing? – Property & Negative Gearing Explained

Click here to download the complete guide to negative gearing property.

 

“A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings.”

Source: ATO

So if the property has more expenses than income it has negative cash flow and because there is a loan on the property the investment is geared. Hence Negative Gearing.

Why do people practice negative gearing?

There are two main reasons people negatively gear their investment properties.

  1. To save tax
  2. To generate a capital gain

Saving Tax With Negative Gearing

The overall taxation result of a negatively geared property is a net rental loss. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income – such as salary, wages or business income – when you complete your tax return for the relevant income year.

Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year. If by negatively gearing a rental property, the rental expenses you claim in your tax return would result in a tax refund, you may reduce your rate of withholding to better match your year-end tax liability.

So instead of having the usual amount of tax taken out of your pay each pay check and then submitting a tax return to get your refund due to the negatively geared property, you can submit a tax variation and have less tax taken out of your pay to begin with.

This means getting your money sooner to put into savings, to invest, or to pay down your mortgage. Getting your money sooner rather than later can make a big difference in the long run thanks to compound interest.

Capital Gains

Property investors hope that by negatively gearing they can make money from the value of the property increasing over time. They hope that the capital gain will be greater than the income loss.

Many property investors never plan to pay down an investment property loan and instead make interest only payments. In this way they are able to keep attaining a tax saving and hopefully the value of the property will continue to increase.

Property investment gains and losses are magnified when borrowing to invest

Gearing increases the exposure to an investment with the aim of increasing the potential return on your capital. The increased exposure and risk makes it crucial to ensure that the correct investment timeframe is identified. Potential losses as well as profits are also magnified. In the example below let's assume a property purchase price of $500,000 with a 20% deposit of $100,000 with 80% borrowed to fund the purchase of a residential property.

Table 1-1 demonstrates the increased gains and risks;

 Table 1-1

20% Deposit and 10% capital growth

20% Deposit and 10% capital loss

Capital-Deposit

$100,000

$100,000

Loan amount (80%)

$400,000

$400,000

Total available for investment

$500,000

$500,000

Return on investment

$50,000

($50,000)

Capital after loan repaid

$150,000

$50,000

Capital gain/(loss)

$50,000

($50,000)

Return

50% Gain

50% Loss

The above table does not take into consideration taxation, transition and borrowing costs, it is for illustrative purposes only.

Learn more...

Download the full guide on property investment here

Find out how negative gearing works with your tax and how it can increase your net wealth

Find out your tax saving each year and how much capital gains you can make with an investment property by using the Investment Calculator – One of Australia’s Most Popular Investment Property Calculator's.