Positive and negative gearing: the pros and cons
If you invest in property, it could be positively or negatively geared. And it has nothing to do with mechanics or engineering.
It refers to whether the income you receive for the property is higher or lower than the overall amount you pay to own it. These can have implications for the investor, not only for how much you have in your pocket week-to-week, but also when it comes to tax.
Here we’ll break down the difference between the two, how to know which your property is, and what it means for you as an investor.
What is negative and positive gearing?
At a basic level, the term ‘gearing’ means money you borrow to invest. Whether you're positively, negatively, or neutrally geared depends on the rental income and your outgoings, including interest and other associated expenses.
- Positive gearing - Your property is positively geared if the income from your investment is more than your interest payments and outgoings like maintenance and repair costs.
- Negatively gearing - Your property is negatively geared if the income from your investment is less than your interest payments and outgoings.
- Neutral gearing - Your property could be neutrally geared, which means the income is equal to your interest payments and outgoings.
This part is pretty straightforward - you’re either actively making money from your investment property, or paying out of your pocket to have the property. However there are other implications such as tax that you should consider.
You may be able to claim a tax deduction for things like body corporate fees, advertising for tenants, insurance, land tax, gardening and cleaning fees, and council and water rates. Check the ATO's rental property guide for a list of things you may be able to claim, and always consult with your tax advisor for more information.
How to calculate whether a property is positively or negatively geared
Whether you already own the property or are looking to purchase one, there are a number of costs to consider when calculating whether it is positively or negatively geared. The amount you have coming in for rent is your income, from which you deduct all your outgoings which can include:
- Mortgage repayments and fees
- Council and water rates
- Land taxes
- Real estate agent fees
- Insurance premiums
- Repairs and maintenance
- Body corporate fees (if applicable)
Beyond this, you can also take into account some potential tax deductions, depending on your circumstances. For example investors may be able to claim some depreciation such as the decline in value over time of the building structure - speak to your accountant for information relevant to your circumstances.
If your income exceeds your outgoings, your property is positively geared. If your outgoings are higher than your income, your property is negatively geared.
Choosing negative gearing as an investor
At first glance, finding a positively geared property sounds like the most logical strategy, however, negative gearing can have its place for some tax-savvy investors. If your property is negatively geared, you'll need to cover the shortfall out of pocket, but it could in turn reduce your taxable income.
Under Australia's tax law, you might be able to claim the interest and some outgoings as expenses. For example, you may be able to claim the interest part of your loan repayments, along with repairs and maintenance costs on the property as expenses. Your net loss on the property could also be offset against your personal income, which means your taxable income would be reduced. So for example, if your salary is $90k per annum and your property leaves you out of pocket by $5k per year, you may be able to deduct this amount from your taxable income, bringing it down to $85k. By the same token, investors with a positively geared property may need to pay tax on their rental income profit. For more information, the ATO provides a guide to rental income and expenses. It is important to speak to your accountant or financial advisor for personalised advice based on your unique circumstances.
Negative vs positive gearing
While negative gearing offers financial benefits, it's important to keep in mind tax savings only play a role in the bigger picture of a viable investment property. So while negative gearing could in some circumstances help you save on tax, this shouldn't be the only reason you're investing in a particular property or the sole driver of your strategy. For example, you may not be looking for regular income from the property but be more focussed on finding a property with high capital growth potential, meaning the value of the property is likely to increase above average over time.
Bottom line: which strategy is best?
Both negative and positive gearing have their place, and the right option will depend on your circumstances. It is a good idea to develop a thorough understanding of how each works, including what, if any, deductions you will be able to claim. Additionally, as an investment, it is a good idea to look for a property with good capital growth prospects.
Property investment isn't without its risks, so make sure you have the financial foundation to cushion a fall in the value of your property, a rise in interest rates, and/or long vacancy periods.
Your Loan Market broker can work with you to understand what your loan repayments could be if you are looking to invest, or compare loans from over 60 lenders to see if you could get a better deal if you refinance.