Negative gearing is the term used to describe a situation in which the total expenses you incur on your investment property exceed the total rental income you derive from the property. Positive gearing of a property investment occurs when the income exceeds the expenses.
For most property investors, by far the largest investment property expense is interest on the loan that was drawn down to buy the property. Negative gearing of an investment property allows investors to offset this expense against the income (rental) from that property. Other expenses may include body corporate fees, council rates, cleaning, property management fees, repairs and maintenance costs, etc.
As your annual outgoings to maintain the investment property exceed the rental income you derive from it, you will be making a net loss, which is numerically expressed as a negative figure.
Coupled with the fact that the loss is commonly attributable to interest expenses from borrowings taken out to buy the property (borrowing is also known as gearing), the term ‘negative gearing’ was conceived, which captures the common scenario in which you make an annual net loss on an investment property due to the interest on the loan, but, technically speaking, other expenses may also contribute to this loss.
In particular, the loss may be further amplified by depreciation and capital works deductions, which are not cash outgoings but are nonetheless tax deductible.
What makes negative gearing particularly tax attractive is that the net loss can be offset against other income that would otherwise be included in your assessable income. Therefore, if a dollar of income would otherwise be taxed at 51.5%, every dollar of negative gearing loss which offsets that income will save you 51.5 cents!
Meanwhile, if the investment property goes up in value but you do not sell the property, no CGT will be payable. Even if you do sell the property after 12 months, the capital gain will be discounted by 50%.
Accordingly, provided that the total after-tax capital gain on your property and the total tax you have saved from negative gearing exceed your total rental losses during your ownership of the property, you will be in front and make an overall net profit from the property.
In other words, negative gearing may provide significant tax savings that may turbo-charge the return on capital on your investment property.
Having said that, negative gearing is a hotly debated topic in the public space at the moment. In particular, the opponents to negative gearing argue that negative gearing encourages property investment by providing significant tax perks that drive up housing prices, which is increasingly making home ownership inaccessible especially to first home buyers.
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