What is positive gearing & how does it work?

Negative gearing is frequently a hot topic of discussion for property investors, but what about positive gearing? Here, we explain what the term means, what you need to know about it, and the differences between negative and positive gearing.

Investing in property is common in Australia, with recent Australian Taxation Office (ATO) statistics showing that more than a fifth of Australian taxpayers own an investment property. If you have an investment property and are renting it out to tenants and earning an income, then it’s possible that this property may be positively geared.

What is positive gearing?

According to the ATO, a rental property you own is said to be ‘positively geared’ if your deductible expenses are less than the income you earn from the property – that is, you make a profit from renting out your property.

How does positive gearing work?

If the income you earn from an investment property covers its costs – that is, the amount you receive from rent is greater than what you pay to maintain the property – then that property is said to be positively geared.

To help understand how this could work, consider the following example: Jacinda has an investment property from which she earns $550 per week in rent. She tallies up her expenses from owning the property, which run to $500 per week.

Based on these amounts, Jacinda can cover the expenses of owning the property with her rental income, and have an extra $50 per week left over. This means that her property is positively geared.

What are the expenses you can deduct from a rental property?

The following is a list of expenses associated with an investment property that can be tax deductible, according to the ATO (depending on individual circumstances):

• advertising for tenants
• body corporate fees and charges
• council rates
• water charges
• land tax
• cleaning
• gardening and lawn mowing
• pest control
• insurance (building, contents, public liability, loss of rent)
• interest expenses
• pre-paid expenses
• property agent’s fees and commission
• repairs and maintenance
• legal expenses.

The ATO says that these expenses are only deductible if you actually incur them yourself, and they are not paid by the tenant of the property.

What are some potential advantages and disadvantages of positive gearing?

As with any major financial decision, there are potential pros and cons to consider. Below is a list of some of them. If you are thinking of buying an investment property, it could be a wise idea to obtain suitably qualified advice.

Some potential advantages of positive gearing might include:

• Earning income from a property: Money earned from a positively geared property could potentially be a way to boost your existing income, and put to use in a variety of ways, depending on your needs, goals and financial position.
• Potential to pay down the balance of your home loan: The income you receive from an investment property can potentially be used to make additional payments to your mortgage, depending on the kind of home loan you have, allowing you to pay off the balance more quickly.
• Attractiveness to lenders: If you wish to purchase another property down the line, then having a property that is positively geared – that is, earning you an income – could make you more attractive to a potential lender when applying for loans.
• Less risk: If you experience a sudden income change – for example, if you lose your job – then having positively-geared property in which the rental income covers the costs could potentially be less risky than if the investment property was not making money.

Some potential disadvantages of positive gearing might include:

• Income you earn is likely to be taxable: It is worth keeping in mind that any rental income you earn on a positively geared property is most likely taxable “at the individual’s marginal rate”, according to the ATO. On the other hand, if a property is ‘negatively geared’ – it’s not making as much as it costs – a property owner might be able to use some of the expenses to offset their income tax. If you would like to know more about what this could mean and the potential implications for your tax return, it is advisable to consult with a qualified accountant or financial advisor.
• Unexpected costs: Real estate firm Coronis advises that you can never know for sure what will happen with a property, and that unexpected maintenance and repair costs can come up at any time, and can end up turning a positively-geared property into a negatively geared one.
• Higher initial cost: Generally speaking, the less money you owe on a property, the less you might be paying in interest to your lender. Smaller mortgage repayments could make it easier to generate a profit from an investment property, but this may mean that your initial outlay to purchase the property will need to be higher.
• Volatility in the property market: While this is not a disadvantage of positive gearing per se, it is worth bearing in mind that in times when interest rates are high, repayments on home loans can be very expensive, meaning it can be difficult for investors to make enough money in rental income to have a property be positively geared.

What should you consider before positively gearing an investment property?

Before deciding whether positive gearing of an investment property is right for you, it could be wise to talk to your accountant or financial planner, and consider the following:

• What will your ongoing costs be? Don’t forget to include maintenance expenses, property management fees, strata or body corporate fees (if applicable), insurance premiums, council rates and utility bills, along with the interest you’ll be paying on the mortgage.
• How much rental income will the property bring you? Remember to allow for potential periods of vacancy between tenants – you can find out the average for your property’s suburb online through sites such as realestate.com.au or domain.com.au.
• What will the potential tax implications be? Refer to the ATO for a guide or speak to a qualified tax accountant.
• What’s the potential for capital growth to offset any short-term losses? You may want to speak to a local property expert, or research historical price growth in the area.
• How will any future interest rate changes affect you?
• How do the property and its possible earnings fit into your overall investment strategy? For example, are you planning on holding onto the property for several years, so you can benefit from the potential capital growth? Or are you more focused on the income you’ll be earning from it right now?
• How do fluctuations in the property market and interest rates affect gearing strategies?

When rents are high due to demand and interest rates are low, it may be easier for an investment property to be positively geared. In times of high interest rates and slow rental price growth, the opposite is generally true. This is because high interest rates mean higher repayments on investment loans, making it more difficult to find a property that can produce a rental yield in excess of the payments.

What is the difference between negative and positive gearing?

Negative gearing is a situation in which the rental income earned from a property is less than the cost required to maintain it, including the interest repayments, maintenance and other expenses. The key difference between negative and positive gearing is that where a positively-geared property makes a profit before tax, a negatively-geared property makes a loss, and may therefore be eligible for certain tax concessions. It is advisable to speak to a qualified accountant or financial planner to determine the potential tax implications of negative gearing in your particular circumstances.

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