Negative and Positive Gearing

Negative and Positive Gearing

Borrowing for an investment property, also known as gearing, can take the form of negative, positive and neutral gearing.

Negative Gearing in particular can be used as a basis for various investment strategies, including purchasing an investment property, purchasing a share portfolio or investing in managed funds.

In essence, you are investing someone else’s money (Bank or Financial Institution) in addition to your own, with the goal being to allow you to accumulate wealth faster by increasing your total investment amount. Economists refer to this in business terms as using ‘economies of scale’ to enhance your investment potential.

Negative gearing and property investment

Negative gearing is when you borrow to acquire an investment property and the interest and other costs you incur are more than the income that you receive from the investment – in other words you make a loss.

This loss is offset against income from other sources, thus reducing your taxable income, and hence the amount of tax that you have to pay – compared to the amount of tax that you would have to pay if you didn’t have the investment property.

An investment property is negatively geared if it is bought with borrowed funds, and the net rental income (after deducting other expenses) is less than the interest on the borrowings.

If you have this kind of rental loss, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income, such as salary, wages or business income.

If this means that your rental expenses would entitle you to a tax refund, you may be able to reduce your rate of withholding.

Across all types of business and income-earning activity, income is taxable, and the expenses incurred in assessing that income are deductable from that income.

Deduction checklist for investment properties

Below is a checklist of typical deductions directly related to rental properties you may be able be claim: (as always check with your accountant to confirm in your situation)

• Body Corporate Fees
• Borrowing Expenses (For example, stamp duty and legal fees on mortgage)
• Building depreciation (depending on date of construction)
• Cleaning Costs
• Council Rates
• Depreciation of fixtures and fittings (light fittings, carpets etc)
• Insurance Costs
• Interest on loans (including interest prepaid up to 12 months in advance) and related bank charges
• Land Tax
• Pest Control Costs
• Property Agent Management Fees
• Repairs and Maintenance (excluding improvements which are treated as capital and added to the cost base of the asset for capital gains tax purposes rather than being claimed as an immediate deduction)
• Telephone, postage and stationary relating to your investment property costs
• Travelling Expenses
• Water Rates

The attraction of negative gearing is that ongoing losses are tax deductible. This reduces your tax bill, effectively boosting returns.

And that, as it applies to property investment, is what allows negative gearing to occur.

But investment properties can also be positively geared.

Positive Gearing

Positive gearing is where the rental returns from an investment property are greater than the outgoings (including interest on the loan). In addition to potentially high rental yields, the cash flow from these properties can be used to fund the acquisition of additional investment properties.

What continues to attract investors to negatively geared properties, apart from the tax breaks, is the prospect of capital growth.

As a general rule of thumb investment properties can be expected to earn either a good rental return or good capital growth. Only rarely does a property yield both.

A positively geared property means that the rent received from your investment property is greater than the costs of owing it, including interest rate repayments and maintenance expenses.

However, property experts note that positive gearing could be tricky because it relies on the rents being high in comparison to the purchase price of the property.

Cheap properties paying high rents tend to be thin on the ground and therefore payment of a large deposit on the property is usually required to push it into the positive zone.

To generate a positive cash flow, investment costs must be lower or equivalent to the income received from the property, taking into account your rental yields combined with tax breaks.

If construction of an investment property commenced after 19 July 1985 you may be entitled to depreciation allowances that will enable you to claim “paper losses” to reduce your taxable income.

The benefit of a property that generates a cash flow is realised when you sell the investment property some-time in the future. This is because you won’t have to subtract the losses incurred over the life of the investment, as is the case with negatively geared properties.

For detailed information on this issue you should seek the advice of a financial planner with expertise in investment property or a qualified accountant.

In the final analysis, prospective investors should always apply the fundamental rule of buying the right property in the right location at the right price.

With capital growth as the ultimate goal these three elements are vital to successful property investment.

Further information on negative gearing, positive and neutral gearing, including an in depth look at negative gearing through an example is available in the free information pack.

Contact us for a free personalised assessment to see how investment gearing could work for you now and in the future.