What Is Negative Gearing On An Investment Property?

Negative gearing occurs when the cost of owning an investment property, such as mortgage interest and maintenance, exceeds the rental income it generates. This creates a net financial loss. For Australian investors, this taxable loss can be used to offset other personal income, potentially reducing your overall tax bill.

While a financial loss might sound like bad news, the strategy can save you money at tax time. Let’s explore exactly how negative gearing works and whether it is the right strategy for your property investment portfolio.

How Does Negative Gearing Work?

Negative gearing works by allowing property investors to deduct their net rental loss from their taxable income. You calculate this by subtracting your total property expenses from your total rental income.

Here is how the process works from a financial perspective:

• Add up everything you earn from tenants over the financial year.
• Include mortgage interest, property management fees, maintenance, insurance, and council rates.
• If your expenses are higher than your rental income, you have a net loss. This is where negative gearing kicks in.
• Deduct this net loss from your primary taxable income, which reduces the total amount of tax you owe.

Example of Negative Gearing in Action

Let’s say you buy an apartment for $300,000. You charge $300 a week in rent, but your mortgage and management costs total $400 per week. That is a $100 weekly shortfall.

Here is how that looks over a financial year:

If you earn $100,000 from your job, that $5,200 property loss reduces your taxable income to $94,800. At a marginal tax rate of 30%, that is a $1,560 reduction in the tax you need to pay.

You can use a negative gearing calculator to see how this strategy stacks up against your personal serviceability.

What Is the Difference Between Negative and Positive Gearing?

The primary difference between negative and positive gearing lies in cash flow. Negative gearing means your property operates at a financial loss, while positive gearing means your rental income exceeds your expenses, creating a taxable profit.

In contrast to negative gearing, positive gearing offers immediate income and improves your borrowing power. However, it is fully taxed and typically offers lower capital growth.

Why Do Property Investors Use Negative Gearing?

Australian investors primarily use negative gearing as a long-term wealth-building strategy. The goal is to endure short-term cash flow losses in exchange for long-term capital growth and immediate tax deductions.

There are two main reasons investors choose this path:

Maximising Tax Deductions: You can claim property losses on your tax, including asset depreciation. When tax season rolls around, this significantly reduces your taxable income.

Achieving Capital Growth: Negative gearing helps you hold high-value real estate. Over time, you can typically earn a capital gain upon selling that far outweighs the short-term losses accrued.

What Are the Risks Associated With Negative Gearing?

While tax perks and capital growth are appealing, negative gearing is never a guaranteed win. A financial loss is still a loss, even if it comes with a tax deduction.

Before investing, every buyer must consider the following risks:

• What happens if you cannot find tenants for a few months? Your rental income drops to zero, but your expenses remain.
• What if property values dip? If the asset does not appreciate as expected, you lose out on the capital growth needed to justify the short-term losses.
• If interest rates rise, your mortgage repayments increase. You may not be able to raise the rent enough to cover the extra cost.

How Can You Minimise Negative Gearing Risks?

You can minimise negative gearing risks by building a financial buffer, choosing high-demand locations, and securing comprehensive landlord insurance.

To protect your investment and build equity safely, follow these strategies:

• Choose the Right Property Location: Location is everything. Buy properties near schools, public transport, shops, and employment hubs. These areas consistently attract tenants, reducing your vacancy risk.
• Be Honest About Your Serviceability: Assess your income strictly. You need enough surplus cash flow to ride out vacancies, cover the weekly shortfall, and handle urgent repairs.
• Get Adequate Insurance: Protect your cash flow. Speak to your broker about landlord insurance, income protection, and trauma cover to safeguard your investment journey.

---

Take the Next Step in Your Property Investment Plan

Negative gearing can be highly beneficial, but only if it fits your specific financial situation and risk tolerance. Before you make a move, you need expert advice to structure your loans correctly.

Make your property investment count with expert guidance from Home Loan Experts. We find competitive rates and tailored loan solutions to maximise your borrowing power.

Talk To An Expert Today or call us at +61 2 9194 1700 for a free assessment!