What is Negative Gearing?
Negative gearing is a popular investment strategy that can assist you to reduce your investment property holding costs. In this post, we explore the concept of Negative Gearing and explain how this strategy is used.
What is Negative Gearing?
Let’s start with an overview of Gearing. The term ‘Gearing’ relates to how you manage the expenses and income of an investment. Gearing applies to any type of investment including stocks and shares.
When it comes to property, Gearing is commonly thought of in terms of Negative and Positive.
- Positive Gearing is where the property generates a positive income stream
- You may be liable for any tax on income generated from this investment
- Negative Gearing is where the property generates a negative income stream or a loss
- You may be able to claim the loss as a tax offset
- Your property investment can also be Neutrally Geared
- This is when the income and expenses break even
Essentially, ‘Negative Gearing’ is a commonly used term used to describe a situation where expenses associated with an asset (including interest expenses) are greater than the income earned from the asset.
Individuals who are Negatively Geared can deduct their loss against other income, such as salary and wages.
Australia’s tax system operates on the principle that people pay tax on their personal income, less any expenses made whilst generating that income (called deductions).
Different people and businesses have different costs for producing income, so Tax Deductions mean you are taxed on your income after expenses are accounted for.
Why do we have Negative Gearing in Australia?
Negative Gearing helps to minimise the short-term costs of holding an investment property and is generally applied where it is expected that in the long-term, rental increases and Capital Growth will overcome any losses.
The aspect of Negative Gearing that some commentators take issue with is that the income loss can be offset against other forms of income, creating a tax reduction.
This policy was brought in to make purchasing and holding a property more affordable and enable investors to get into the market to access long term Capital Gains, even if the property isn’t turning a profit in the short-term.
The tax benefits available for Negative Gearing are intended to help people buy investment properties by minimising potential short-term cash flow issues.
Essentially, the intent of the policy is to stimulate the housing market through private investment. Without such stimulus for privately purchasing investment properties, there would need to be other avenues to ensure the continued supply of affordable housing.
What else should I know if I am considering Negative Gearing?
Negative Gearing is a long-term property strategy that should only be adopted if you can sustain a shortfall.
With this in mind, you should consider how you would cope in a range of worst-case scenarios. All types of investment experience cycles. These cycles are triggered by factors such as rising and falling interest rates and property values, changing government policies, population demographics, and unforeseen events.
Depending on your goals, you may choose negatively geared properties positioned for stronger capital growth, and/or positively geared properties for an income or to offset any losses. It all comes down to what you aim to achieve in the short- and long-term.
A long-term strategy
At the end of the day, your long-term goals should dictate the investment strategy that best suits your circumstances. A good strategy will help you choose an investment that creates a balance between returns and security that suits you.
Negative gearing is a long-term strategy that, if successfully executed, should pay dividends through Capital Growth.
Buying an investment property is a serious financial decision. We recommend that property investment forms part of an overall financial strategy. This strategy should be based on your current financial position and personal circumstances.
We have a network of reputable Financial Advisors and Accountants we can recommend if you would like to talk to someone about creating a strategy to meet your goals.
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