It’s mentioned continuously by advisers, the media and banks but how can something negative be positive?
Simply put negative gearing is a term used to describe a financial practice whereby you reduce your tax bill by offsetting the loss you make on a negatively geared property against your taxable income.
- A property is negatively geared when the interest you are paying on loan is more than the income you earn from the rent. As a result, you are making a loss.
- Property is neutrally geared when the interest you are paying on loan is equal to the income you earn from the rent. As a result, you are breaking even.
- A property is positively geared when the interest you are paying on loan is less than the income you earn from the rent. As a result, you are making a profit.
So how is negative gearing beneficial?
The key benefit associated with negative gearing is that any loss may be offset against other income earned, such as your salary, reducing your taxable income and therefore your tax payable.
Target high growth market
Other factors include targeting high growth market. Australia is very much a growth market, meaning that even if you invest in positive cash flow property, the chances are that you want to achieve some capital growth to get the significant return on investments that you desire.
To be sure, people invest in properties to make money. But most investors who rent out properties don’t expect to make money on the rent.
Instead, they buy properties with the intention of cashing in on a property’s long-term capital growth. Which is to say, they buy a property in the hope that its value will eventually increase to a point whereby a healthy profit can be made from its sale.
Leverage for Greater Returns
Another great benefit of negative gearing is that if you achieve the capital growth that you want, there is the opportunity to leverage against that to get more substantial returns and to expand your portfolio.
As you property goes up in value, it may be possible to borrow against that increased value to use that as a deposit on another property and expand your portfolio without actually injecting any more cash into these investments. And so, the aim of the game for investors is to limit their losses until the time comes for them to sell – and negative gearing is a good way to do that.
Essentially, negative gearing works if the money an investor makes from a property’s capital growth is greater than the loss they make from the rental shortfall.
