What is Negative Gearing?
Borrowing to invest in a property is known as gearing. If your interest on a loan and running costs of the property add up to more than your investment’s income, you are making a loss on the property, referred to as ‘negative gearing’.
It may seem unintuitive, but the reasoning behind a negative gearing strategy is to get in to the market early, and increase your investment income over time to eventually cover your expenses. Until that time, you are generally able to claim your net loss as a tax deduction against your regular income. This tax saving can be paid as a refund at the end of the financial year, or you can vary the tax withheld from your pay during the year instead.
Example of tax savings
You are a PAYG employee on an $70,000 salary, and own a rental property. The property collects $15,000 a year in rent, but costs $25,000 a year in interest and running costs, leaving a $10,000 loss on the property overall. This reduces your taxable income to $60,000, thus saving you 30% tax, or $3,000 on the reduction. This example makes it clear that the after-tax loss on negative gearing is $7,000, and is moderated by the tax reduction you receive.
Combining depreciation and negative gearing
Taking the example above, let’s also look at what happens when you claim depreciation benefits on the property. The rental income is still $15,000, costs are $25,000, and we’re adding in a depreciation claim of $4,000. This means your cash loss for the year is $10,000, and your net rental loss for tax purposes is $14,000. Your taxable income now drops from $70,000 to $56,000, with the 30% tax saving now being $4,200. This has reduced your after-tax loss to just $5,800.
But isn’t the goal of investing to make a profit?
Even if you’re saving on tax by making a loss on your investment property, you are still losing money. However, investors still buy negatively geared property because the growth read more…