Negative and positive gearing explained
You’ve probably come across the term ‘negative gearing’ in relation to property investing. When it comes to investing, the term 'gearing' refers to borrowing to buy an asset. It is simply a way to describe borrowing to invest. So if you take out a loan to buy a rental property, your investment is said to be geared.
Most investors use some gearing in the form of their mortgage, to fund their rental property.
It can all be a bit confusing though, so let's take a look at what it means.
How does negative gearing work?
Negative gearing occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.
The benefits of a negatively geared property
Let's take an example of a negatively geared property in Australia. Let's say that Bill owns a rental property generating $25,000 in rent each year. The costs of holding the property, including mortgage interest, come to $30,000. This gives Bill a taxable loss of $5,000, which he can use to reduce the tax payable on his salary.
If you know in advance that your investment will record a loss over the financial year, you can apply to the Tax Office to reduce the amount of tax taken out of your salary. This is called PAYG Withholding Variation and it can provide a real boost to your personal cash flow. You can chat with your mortgage broker about options and with a tax adviser or accountant for more details.
Negative gearing investment properties often plays a significant role in all investors’ strategies. Knowing your investment strategy is important, and getting expert financial advice is smart if you need help identifying the right approach to maximize your profits.