It is one of the hottest topics in Australia at the moment, but can also be one of the most misunderstood. So what exactly is negative gearing?

Simply, negative gearing arises when the cost of owning a rental property outweighs the income it generates each year. It creates a loss, which can generally be offset against your other income – say your salary.

For example, let’s say Jane owns an investment property that brings in $13,000 rent each year and the costs of holding the property (including the interest on the home loan) come to $15,000 in the same year. It means Jane has a taxable loss of $2,000, which she can use to reduce her tax payable.

Obviously nobody enters into an investment wanting to lose money. Even though property investments will often be negatively geared, the benefit can come from capital growth. Using the above example again: imagine Jane bought the property for $250,000 and took out a loan of the same value (using equity in her existing owner-occupied property). At a rate of 6% the annual interest repayments would total $15,000. As we know from above, she is making a $2,000 loss compared to the incoming rental income.

The good news comes in if the property increases in value over time. If the value increased at a rate of 4% each year for five years it would be worth around $304,000 in five years’ time. While she has incurred $10,000 worth of losses, she has built in $54,000 worth of equity, or profit, if she were to sell (though don’t forget to consider and factor in capital gains and tax implications at this point).

Risks

There may be some benefits associated with negative gearing, but with any investment there will also be risks to consider. Negative gearing still ultimately means you are recording a loss. And you should always properly consider, and obtain the appropriate advice for, the risks involved, which include:

  • What happens if you have trouble renting out your property?
  • What if there is a turn down in values and your property doesn’t increase in value?
  • What if interest rates increase suddenly and your loss is substantially larger?

These are important questions that should be explored properly. Union Shopper Mortgage Planners can assist along the way, and we also recommend seeking independent financial and tax advice to help you make the best possible decisions to secure your financial future.

This is general information only and is not to be considered tax or financial planning advice. You should seek advice that is specific to your circumstances from the relevant professionals.