Negative Gearing A Simple Explanation

Negative gearing is a popular tax minimisation strategy for many property investors.

For most, this is a short-term solution until an investment property can start making a positive cash flow.

However, some choose to remain negatively geared as part of a longer-term strategy.

Negative gearing allows investors to offset losses from their investment properties to reduce their taxable income, effectively ‘saving’ money on their tax bill.

In essence, you only reduce your tax if you reduce your income.

This is common tool for property investments, for example, where rental income is less than interest and other expenses.

It can provide a financial boost in the short-term, which is particularly beneficial in the early years of owning an investment property.

Although it reduces taxable income, a negatively geared investment property is still running at a loss. Investors should consider if they have the financial means to cover these losses each week, month and year.

You may be prepared to accept a loss if you expect to be able to offset your losses with a capital gain in the future when the value of the investment increases.

Another form of property investment, the rent-and-invest strategy, is on the rise. This is where investors buy a rental property while living in and renting a different property. They now make up 8% of first-home buyers nationally according to a report by the Reserve Bank ofAustralia.

Such investors are also negatively gearing their property.

Besides the tax advantages, negative gearing has a slew of other benefits like easing mortgage pressure, the ability to target high growth areas, and the opportunity to add value almost instantly through things like renovations or subdivisions.

It also allows new investors to get on the property ladder and begin building equity.

A key advantage with having a propertynegatively geared is the potential forcapital growth. So, while you’re benefiting from lower taxes, your property should still be increasing in value.

The investment property is also made more affordable for tenants, making it easier to secure a long-term tenant.

However, investors need to be aware of the higher financial risk involved. Investors are vulnerable to fluctuations like sudden interest rate rises and falls in real estate prices.

A good cashflow is required to cover out-of-pocket expenses to maintain the property, plus budgeting for ongoing shortfalls and capital gains tax when the property is sold for a profit.

There are some political considerationsto take into account. Negative gearing can be a political hot potato.

On both sides of the political fence, there are ongoing arguments for and against negative gearing, as well as calls for changes to legislation. Some argue that it is beneficial for investors, while others believe that it harms first home buyers and non-investing taxpayers.

Investors should consider how any future changes could affect their investment and financial position.