What is Negative Gearing?
Negative gearing is a tax benefit you can claim if your borrowing costs are higher than the money you’ve made from an investment property. These losses can be claimed against your total income and increase your tax return and therefore, your income on your investment.
For example, Jenny had a $50,000 deposit and borrowed $350,000 to buy a $400,000 investment property. Her annual repayments total $28,000 on the interest only loan at 8%. She rented this property at $400 per week, or $20,800 per annum so she actually lost $7,200 per year. Plus there were other expenses: rates, levies and maintenance costs which added up to $3,500. Jenny has now spent $10,700 to own that asset over and above the income she received.
Jenny will be able to claim this $10,700 loss against her taxable income by $10,700, this reduces what she might have to pay in tax. That’s negative gearing because it involves a loss.
Why Negative Gear
Most investors are willing to accept a loss in income if they believe they will be compensated by capital growth in the future. The catch is you have to fund this shortfall while you wait for the investment to appreciate in value. You’ll also need a taxable income to negatively gear this loss against. The higher your income, the higher the benefit of negative gearing as it will decrease your taxable income so negative gearing is a better option for high income earners.
What is Positive Gearing?
Positive gearing is the exact opposite of negative gearing, this is when the income from your investment property exceeds the cost of owning the property when you take into account your loan repayments, interest and all other out of pocket expenses (like rates, water and maintenance costs). If you have a property that is positively geared, you will be enjoying a net gain from your investment. If you making an income from the investment it is cash flow positive.
Why Positive Gear?
Positive gearing is a good option if you are retired (as you will no longer have a taxable income to offset against the loss) or you don’t have a high taxable income. Positive gearing means you are making money on your investment property and you will also hopefully enjoy capital gains too. Beware however that property prices go up as well as down and interest rates may not stay this low forever so your costs could increase and the value of your property could decrease. Consider also the cost of having your cash tied up in the form of a deposit.
Buy good quality investments, preferably with a reliable and rising income stream. Borrow conservatively so you can survive interest rate rises and possible loss of income. Maintain reliable income from your job or other sources to cover your borrowing costs, especially in the early years and make sure you claim your depreciation costs to increase your return.
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