The phrase ‘negative gearing’ is thrown around a lot online and in the news. But what exactly is negative gearing? And how does it affect property investors?
The term ‘gearing’ refers to the process of borrowing money to purchase an asset, such as an investment property. If that property is positively geared, it means the income you gain from rental payments is more than the interest you are paying on the money you borrowed.
Therefore, negative gearing refers to an investment where the rental return is less than the cost of owning and managing the property.
Advantages and disadvantages of negative gearing
If you have a negatively geared property, you essentially have a loss of income. But in Australia, that loss can be offset against your other sources of income, including your salary – meaning that your total taxable income, and therefore the amount of tax you have to pay, is reduced.
These tax benefits are one of the main reasons many property investors choose to take advantage of negative gearing. Other benefits for investors include:
- Future capital gain, which will further offset negative gearing losses
- Wider range of properties to choose from – finding properties with positive cash flow can be difficult, and if you choose to utilise negative gearing you’re more likely to find a property in a stable, high-growth area.
However, the potential downsides of negative gearing should be kept in mind, too. Some of the disadvantages of buying a negatively geared investment property include:
- The need to still have enough income to maintain out-of-pocket costs
- The risk of not being able to absorb the effects of falling property values.
The current situation
At the beginning of 2018, the Labor party confirmed that it would take its proposed negative gearing restriction policy to the next federal election. If implemented, this policy would limit negative gearing to new dwellings, as well as cutting capital gains tax discounts from 50% to 25%.
According to analysis from the Treasury, the proposed changes to negative gearing would only put a ‘relatively modest’ downward pressure on property prices. But the potential impact of this policy should be kept in mind by investors, as well as the other risks and benefits of negative gearing mentioned above.