Your Essential Guide To Negative Gearing

Terry Anson
February 21, 2019

SENIOR PROPERTY CONSULTANT

Is positive or negative gearing best for investment properties?

We break it down and look at what’s in the pipeline for existing and future investors.

What is negative gearing?

In Victoria, about 6 out of 10 rental properties are negatively geared, according to data from the Australian Tax Office, reported in the press. Essentially, ‘gearing’ means borrowing money in order to invest, and whether it’s positive or negative depends on if you’re making an income or not..

So there are three types of gearing when you’ve borrowed money to invest:

  1. Positive gearing This is when the income or rent you make from the investment is more than the outgoings, so you’re making money on your investment (and you can decide to use the surplus to reduce the loan).
  2. Neutral gearing This is when the income or rent is equal to your expenses, so you won’t be able to deduct any losses from your tax.
  3. Negative gearing This is when your income or rent your tenants pay is lower than your interest repayments and the money you’re spending on the property, which might include maintenance, fees to a property manager, council rates, insurances etc – so you’re essentially operating at a loss.

How can negative gearing work for an investor?

The idea of negative gearing and making a loss on your investment doesn’t sound too good on paper – after all, you’re investing in order to make money, right? However, a negatively geared property has one main benefit: investors can deduct any losses from their taxable income from other sources. This in turn reduces the amount of tax you pay and makes it far easier to invest in the property market.

And meanwhile, the value of your investment property is going up, and you’re getting more capital gains than you spend in expenses. So savvy investors who make losses in the short term will be hoping for good long-term capital growth and the chance to net a healthy profit when selling the property down the line. Negative gearing can also change to positive gearing over time as you pay down your loan.

When is negative gearing a good idea?

Ideally, you will want to negatively gear your investment property if:

  • You’re a high-income earner. This will mean you probably have enough disposable income to afford the repayments and pay for what’s required on the property while you wait for it to go up in value.
  • You want to save money on tax. If you’re in a high tax bracket because of what you earn, negatively gearing a property probably makes a lot of sense.
  • The housing market is booming. Negative gearing during a period of strong price growth means the value of your property and rental returns are likely to increase, so you’ll benefit from the property’s long-term capital growth potential.
  • You want to add value to the property. Renovating or doing cosmetic updates on adds value to the property and helps you build equity.

When is negative gearing not a good idea?

Negative gearing isn’t ideal for all investors and deciding if it’s the right thing for you depends on your situation. You might not want to negatively gear a property if:

  • You’re pretty stretched financially. Spending more than you can afford on your investment property is a one way ticket to financial stress and possibly bankruptcy.
  • The housing market is slow. In a weaker property market, the value of property declines and can take years to recover – and if you’re throwing money at an investment that’s not accruing in value, what do you stand to gain? Not much.
  • You want to invest in other properties. If building a property portfolio is your priority, you need to consider your disposable income and whether negative gearing is going to work for you long-term.
  • Your goal is financial freedom. If you’re close to retirement or in a lower income bracket, positively geared investments will be better for generating passive income.

How could negative gearing laws change?

Proposed new rules for negative gearing have been front and centre in the run-up to near year’s Federal election, and for good reason.

If elected in 2019, a Labor government plans to place restrictions on negative gearing. According to the proposed legislation, claiming negative gearing benefits would be restricted to off-the-plan or brand new property developments only. The restrictions would also apply to other assets such as shares. Existing investors with multiple properties would still benefit from tax breaks for interest expenses on a portion of their investments, but financial experts predict future investors may be worse off.

If you purchase a property/asset before the policy begins it will be exempt under a grandfathering arrangement – and Labour has indicated that any policy changes would not commence until 2020 if the election is held towards the end of the financial year.

Before negatively gearing a property, always talk to an accountant or financial planner who can help you weigh up your circumstances and risk profile – and how current or future laws might affect you.

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