What is negative gearing?

The term gearing simply refers to borrowing money in order to buy an asset. Negative gearing means you have borrowed money to buy a property, and the rent you charge doesn’t cover your expenses relating to that property. This effectively means you are losing money by holding the investment property. At the end of the financial year you would declare a loss on your tax return.

Why would someone negatively gear their investment?

Some investors prefer to have their properties negatively geared (operating at a net loss) because they are able to claim is as a tax deduction. This may make sense for some, but not all, investors. Over the years I’ve had a number of clients come to me with instructions from their accountant to buy an investment property and negatively gear it to claim the tax deduction, although I don’t always find this is the best outcome from a cash flow perspective.

You do have to consider if this is the right strategy for you. If your property is negatively geared it does mean you’ll have to contribute your own funds to the cost of maintaining the property throughout the year.

Isn’t is just for rich people?

Being in the finance and property industry, I guess I have a bias to keep negative gearing going as it’s helped hundreds of my clients get ahead with property. Some people say negative gearing is only for the rich, and they are wrong! I have clients with modest incomes, who have been committed to growing their wealth through property and the way they have been able to afford this is through negative gearing. Most of my clients predominately own one or two investment properties as part of their wealth creation plans.

Negative gearing helped me in my 20’s to hold three properties which I could only do it with negative gearing! It really set me up well financially and I’ve been able to reap the benefits since.

What does negative gearing look like?

When explaining negative gearing, to make it simple, I say the property is like your own small business, you have income and expenses. Whatever the loss is at the end of the year is what you can claim as a loss off your taxable income.  See example of a $600,000 investment property below:

Purchase Price – $600,000
Loan Amount – $640,000*
*We have assumed you have borrowed the full amount plus stamp duty leveraging equity from another property.

The total loss of $15,445 which you have paid out of your pocket to hold your investment property can now be claimed as negative gearing.  If we assume an income of $100,000 paying 37 cents in the dollar, then this is how negative gearing makes holding this property more affordable:

$15,445 x 37% = $5,714 as a tax refund for the owner of the property.
Meaning the true holding cost after tax is $9,731.

The percentage of negative gearing you can claim, is dependent on your individual salary and the tax bracket you fall under. As you reduce your taxable income from negative gearing, you may fall into a lower bracket which will reduce the benefit of negative gearing.

Additionally, it’s important to point out that only the interest paid on the loan is tax deductible not the principal.

How do investors maximise their negatively geared property?

Investors tend to maximise investment home loans and set as interest only as they can be claimed as a tax deduction. That’s why they utilise the equity in their home to finance 100% of the investment property and the related costs (e.g. stamp duty, conveyancer cost, etc.).  At the same time, investors pay down non-deductable debt that includes their home loan, personal loans and credit card debts.

If you have no non-deductable debt remaining, many investors offset their investment loans rather than paying them off, as they’re better off not spending $1 to get 37 cents back.

How can I negatively gear with interest rates so low?

Something interesting we’re noticing is given interest rates are at incredible lows right now (anywhere from 2.79% fixed rate for investors) it’s actually pretty hard to have a property negatively geared (unless rental yield is very low).

Here’s the same example from above with the lower interest rate applied:

I haven’t included depreciation costs in the above tables, as this differs quite substantially across properties depending on their age and condition.

Seek advice before you purchase property

Negative gearing can have some substantial tax benefits despite seeming like a somewhat risky investment strategy. Before you purchase property make sure you get advice on the best investment strategy for you – speak to your accountant, broker and financial planner first and then make an informed decision from there.