What Is Negative Gearing?

Let’s take a look at what negative gearing is, how it works, some potential pros and cons and what questions to consider when assessing this option.

The term ‘gearing’ refers to borrowing money to buy an asset. In property circles, it means taking out a home loan to buy real estate.

There can be positive gearing, where the rental income an owner gets from a property exceeds the interest repayments, property maintenance costs and other expenses they pay on it. Negative gearing is the opposite, where the rental income is less than the cost of the mortgage, property maintenance and other costs. In short, positive gearing refers to making a profit out of your investment property, while negative gearing means you’re making a loss and are eligible for some tax concessions.

Positive gearing isn’t always possible right away, which is why some investors turn to negative gearing.

What investment property expenses can be claimed as tax deductions?

According to the Australian Tax Office (ATO), the costs of owning an investment property can be divided into two main categories:

  • Non-cash costs such as any depreciation in the property’s value
  • Cash costs such as interest payments, bank fees, insurance premiums, property management fees and maintenance costs

If you add the amount of cash and non-cash costs together and they are more than your rental income from the property, then there is a net rental loss and your property is ‘negatively geared’. You could then claim this loss as a tax deduction against your taxable income, such as your salary.

There are several other expenses property investors can also claim tax deductions for, including advertising for tenants, insurance for the property, real estate management fees and buying ‘capital items’ such as dishwashers or other appliances.

On the other hand, the ATO advises that investors can’t claim other costs that they don’t actually incur, such as utility bills paid by their tenants.

On 1 July 2017, negative gearing concessions were tightened, with the key change being travel expenses were no longer allowed as a deduction for property investors. Plant and equipment depreciation deductions, that is tax deductions an investor can claim for the wear and tear of fixtures, were also limited to those bought by investors. This was designed to prevent investors claiming a deduction where they have bought an investment property that already contained such property fixtures.

To successfully make tax deductions for negative gearing, you are required to keep official documentation of the expenses you’ve incurred on your investment property, including bank statements and receipts.

For more tips about rental property deductions, check the ATO website:

https://www.youtube.com/watch?v=ha3GotMHwPM

Source: Australian Taxation Office

 

Pros and cons of negative gearing

As with any investment strategy, there are potential drawbacks as well as potential benefits to negative gearing.

Pros

Potential tax savings:

Property investors can use negative gearing to try and turn their investment losses into a positive, by offsetting them against their taxable income over a financial year, meaning they pay less in tax for that year. If you’re disciplined with your investments, then negative gearing could be one way to help you minimise the impact of any investment losses over the short-term.

Capital growth:

Besides tax savings, arguably the biggest benefit of negative gearing is that it can help an investor afford to own a property with the potential for high growth in value over time, even if it can’t attract as much rental income as you might like in the short term.

Properties that have positive cash flow immediately can be costly and hard to find in many cases, but even if there’s no immediate return, negative gearing could entice you to purchase a more affordable property that may increase in value in the future.

More property options to choose from:

Negative gearing can potentially open up the range of investment properties someone can choose to buy. This may allow an investor to buy in a capital city or somewhere that is popular and more likely to attract tenants. Investing only in positive cash flow properties restricts investors to certain areas where the rental income exceeds expenses.

Cons

Cash flow risks:

If you’re negatively gearing, you need to regularly pay more money out of your own pocket than you get back from your tenants in rent. As a result, negatively geared properties can eat into your cash flow. This situation can be exacerbated if your tenants move out and you find it hard to attract new ones. Interest rate increases on your home loan could also affect your cash flow.

It could also be worth keeping in mind MoneySmart’s advice that if you’re making a regular loss on your investment property, it’s costing you money and you will need a separate job or other source of income apart from the rent your tenants are paying.

Capital growth risks:

It may take many years before the value of your investment property grows, if it grows at all. During this time, you will be subject to house price fluctuations. The risk of having a property that costs more than the income it generates means you could find yourself in a situation where you can no longer afford to keep it and have to sell before there is any capital growth. A worst-case scenario is that you have to sell the property for less than what you originally bought it for.

Can affect your borrowing power:

Negative gearing can limit how many investment properties you can buy at a time. In the eyes of lenders, a negatively geared property or properties can adversely impact your investment property borrowing power, also known as serviceability.

Should I use negative gearing? Is negative gearing right for me?

Here are some questions that could be worth considering before deciding on whether negative gearing is a suitable property investment strategy for you:

  • How rentable is the property? Is it in a good area? And will people want to live there?
  • What will I do if I can’t find a tenant?
  • Do I have the means to manage my property and the tenants that live in it?
  • What is the capital growth potential of the property? Or in other words, how much do I think it can grow in value before I sell it?
  • Would I still be able to afford the home loan repayments if interest rates were to rise?
  • How long will it take before the investment is positively geared?
  • Could I still afford to live comfortably on the money I earn, knowing that I would be losing money on this investment?
  • Will I be able to recover from a cash flow shortage?
  • Does the potential tax benefit I might make from negative gearing (combined with the profit I could make when I sell the property), outweigh the cost of losing money on this investment?
  • Might other investment options be better for my situation? (e.g. investing in other assets such as managed funds or superannuation, or paying the money into the mortgage on your own home)
  • You may find it beneficial to consult a financial adviser before committing to what is a significant investment decision.
  • If you’re ready to choose an investment loan, Canstar compares thousands of home loans to help you find a suitable mortgage.

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