Negative Gearing Investment Property: How It Works

March 1, 2024

Simon Madziar
Simon Madziar

Key Highlights

  • Negative gearing and positive gearing are two strategies used in property investment
  • Negative gearing occurs when the expenses of owning a property exceed the rental income
  • Positive gearing occurs when the rental income exceeds the expenses of owning a property
  • Negative gearing can provide tax benefits by reducing taxable income
  • It's important to consider the financial implications and risks of negative gearing before investing in property
  • Both negative and positive gearing have their pros and cons, and the best strategy depends on individual circumstances

Introduction

Property investment is a popular approach for individuals looking to grow their wealth and secure a stable income stream. One of the key considerations in property investment is the concept of negative gearing. Negative gearing is a strategy that involves using a property investment to generate a tax deduction by offsetting the expenses of owning the property against the rental income received. However, it is important to note that negative gearing may not always result in enough income to cover the cost of the asset. This blog will explore what negative gearing is, how it works, and its implications for property investors.

Understanding Negative Gearing

Negative gearing, in the context of property investing, refers to a situation where the expenses associated with owning an investment property exceed the rental income received. This results in a net loss, which can be used to reduce the investor's taxable income.

Negatively geared properties have become a common investment strategy for many individuals in the world of real estate investing. By purchasing a property that generates a rental income lower than the expenses of owning it, investors can claim a tax deduction for the shortfall. This tax deduction can then be used to offset other taxable income, reducing the overall tax liability.

How Negative Gearing Works in Property Investment

To understand how negative gearing works, let's consider a scenario where an investor purchases a property using a mortgage. The investor receives rental income from tenants, but this income is not sufficient to cover the interest on the mortgage, property management fees, maintenance costs, and other related expenses. As a result, the investor incurs a net loss on the property, particularly in countries like Australia. This net loss can be used to reduce the investor's taxable income, resulting in potential tax savings.

The Financial Implications of Negative Gearing

Negative gearing can have both positive and negative financial implications for property investors. It is important for investors to carefully consider their financial situation, cash flow, and long-term investment goals before choosing to negatively gear a property.

Impact on Your Tax Return

One of the main benefits of negative gearing is its impact on the investor's tax return. By deducting the net loss from the property against their other taxable income during the financial year, investors can potentially reduce their overall tax liability. However, it's important to note that the tax benefits of negative gearing may vary depending on individual circumstances and tax regulations. Seeking advice from a qualified tax professional is recommended to ensure compliance with tax laws and optimise tax savings.

Key Financial Factors to Consider

When considering negative gearing as an investment strategy, it is essential to take into account various financial factors. These include the potential for capital gain, the annual rent received, and the related expenses of owning the property, including depreciation. Calculating these factors accurately can help investors determine whether a property is suitable for negative gearing and assess its overall financial viability.

Positive Gearing vs Negative Gearing

Positive gearing and negative gearing are two different strategies used in property investment. While negative gearing involves using the net loss from a property to reduce taxable income, positive gearing occurs when the rental income exceeds the expenses of owning the property.

What is Positive Gearing?

Positive gearing is a strategy where the rental income generated from an investment property is higher than the expenses associated with owning the property. In this scenario, the investor makes a profit and is subject to tax on the rental income received. Positive gearing, also known as a positively geared property, can be an attractive option for investors looking for immediate cash flow and regular income from their investment property.

Differences Between Negative and Positive Gearing

There are several key differences between negative and positive gearing. These differences include the impact on cash flow, the tax savings, and the overall investment strategy. It's important for investors to understand these differences and consider their individual financial goals and circumstances when deciding which strategy to pursue.

The Pros and Cons of Negative Gearing

Negative gearing, like any investment strategy, has its pros and cons. It's important for property investors to carefully consider these factors before making a decision.

Benefits of Negative Gearing for Property Investors

One of the main benefits of negative gearing is the potential tax deductions it offers. By offsetting the net loss from the investment property against other taxable income, investors can reduce their overall tax liability. Additionally, negative gearing can also provide opportunities for capital growth and long-term wealth creation. You can be cash flow positive but if you have large depreciable expenses and capital works deductions you can show a loss on the property in your tax return without been out of pocket. Over time the deduction for depreciable assets reduce meaning you have less to claim causing your property to become cash flow positive.

Risks and Drawbacks of Negative Gearing

While negative gearing can offer tax benefits and potential capital growth, it also comes with its pitfalls and drawbacks. Investors need to consider the financial risk of covering the expenses of the property out-of-pocket, the need for sufficient income to support the investment, and the importance of choosing the right property for negative gearing. Understanding the potential risks and drawbacks of negative gearing is crucial before committing to this investment strategy.

Calculating Whether a Property is Negatively Geared

Calculating whether a property is negatively geared involves assessing the income generated from the property and comparing it to the expenses associated with owning the property. Several essential calculations can help determine whether a property is suitable for negative gearing.

Identifying Negatively Geared Properties

Identifying negatively geared properties involves analysing various factors, including property values, interest repayments, and potential tax deductions. Investors can use these factors to evaluate the potential for negative gearing and make informed investment decisions. These calculations can provide valuable insights into the financial viability of a property and inform investment decisions.

Strategies for Utilising Negative Gearing

Utilising negative gearing effectively requires careful planning and consideration of individual financial situations and investment goals. Implementing effective strategies can help maximise the benefits of negative gearing and minimise financial risks.

Planning for Negative Gearing

Planning for negative gearing involves considering factors such as property investment, tax savings, and the involvement of a financial advisor. Having a clear plan in place can help investors navigate the complexities of negative gearing and make informed decisions.

Effective Negative Gearing Strategies

There are several effective strategies that property investors can employ to make the most of negative gearing. These strategies include optimising cash flow, considering property values, and developing a long-term investment strategy.

Negative gearing calculator

Negative gearing is not necessarily a deliberate strategy, as interest rates and other expenses can rise much faster than the increase in rents. This can leave many investors vulnerable to having to cover the investment costs. If you're unsure if your property is negatively geared, you can use the 'Your Mortgage' negative gearing calculator to find out.

Conclusion

Negative gearing can be a powerful strategy for property investment, but it's essential to understand the financial implications and risks involved. By leveraging the tax benefits of negative gearing, investors can potentially reduce their taxable income and build wealth over time. However, it's crucial to carefully consider factors such as cash flow, interest rates, and property market conditions before implementing this strategy.

If you're unsure whether negative gearing is right for you or have questions about how it affects your taxes or claim ability on investment properties, don't hesitate to get in touch with our team of experts. We're here to provide personalised advice and guidance to help you make informed decisions and maximise your investment potential. Contact us today for a consultation and take the first step towards achieving your property investment goals.

Frequently Asked Questions

Is Negative Gearing Right for Me?

Whether negative gearing is right for an individual depends on various factors, including their financial situation, investment strategy, and goals. It is recommended to consult with a financial advisor or property investing expert to determine if negative gearing aligns with personal circumstances.

How Does Negative Gearing Affect My Taxes?

Negative gearing can have an impact on an individual's taxes by reducing their taxable income through the deduction of property-related expenses. This can result in potential tax savings for property investors.

Can you claim negative gearing on investment property?

Yes, investors can claim negative gearing on investment properties. By offsetting the net loss from the property against other taxable income, investors can reduce their overall tax liability. It is essential to seek advice from a qualified tax professional to ensure compliance with tax laws and optimise tax savings.

Is negative gearing risky?

Negative gearing comes with its risks and drawbacks. Investors need to consider the financial risk of covering property expenses, the need for sufficient income to support the investment, and the importance of choosing the right property for negative gearing. It is recommended to carefully assess individual circumstances and seek professional advice before pursuing negative gearing as an investment strategy.

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*Please note that the above information is general advice only. We recommend you seek advice from a specialist relevant to your personal situation. This information is correct at the time of publishing and is subject to change*

Tax laws and regulations can change over time, so it is important to stay informed about any updates or amendments that may affect your tax obligations. The Australian Taxation Office (ATO) is the authoritative source for the most up-to-date information regarding tax requirements and regulations in Australia.

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