You’ve probably heard the term negative gearing, or even positive gearing, in the media, or around friends and family. The reason we hear the term thrown around so much is usually in relation to government policy changes. Even small changes to how negative gearing works can have significant repercussions for investors.
Changes to negative gearing has ability to impact the potential returns that property investors stand to gain, which can cause panic in the hearts of investors. These changes can then affect how many investors are buying property, which, on a grand scale, can influence property prices.
When applied in a certain way, negative gearing can help investors increase their gains on rental properties. So, what is negative gearing and how does it work?
What is negative gearing?
Gearing essentially means borrowing money to buy an asset or investment. Positive gearing is when you’re borrowing money to fund an investment but the return you’re making, including rent as well as any costs of running the property, such as rates and maintenance, puts you in a positive position overall.
Negative gearing, on the other hand, is when a “geared” investment puts the investor at a loss. That means that despite the fact that an investor is getting rental income from your property, that rent is not enough to cover the mortgage repayments, as well as property maintenance and other costs associated with the property. Of course, ideally, you never want to make a loss on your investment; this seems counterintuitive. But a negatively geared investment isn’t all bad news.
How negative gearing works
Negative gearing doesn’t sound too appealing. Yet, many investors are happy to own property that is negatively geared for the following reasons:
- Even though a property is negatively geared, the long-term anticipated capital gains for that property may offset any short-term losses
- Taxable losses from negatively geared property can be offset against other annual income to create tax savings
How to take advantage of negative gearing
So, what are the benefits of negative gearing? Negative gearing allows property investors to limit any losses on property.
Let’s say your rental return from your investment property is $30,000 per year. However, your mortgage interest, property maintenance costs, rates, and other costs come to $35,000 per year. This means that you would be $5,000 out of pocket. Yet you can use that $5,000 to offset your taxable income for that year.
Regardless, negatively geared properties are only worthwhile investments if the capital growth is more than the combined total of any losses on the property each year. Usually, this means that investors need to hold on to a property for long enough to see a substantial return.
The advantages of capital gains
When it comes to property investing, however, there’s more to the story than positive or negative gearing. Often, and especially in most major cities in Australia, the long-term capital gains on a property are substantial. These gains can outweigh any short-term losses. So, even if your property is negatively geared in the short term, your investment may still work out in your favour. In most cases, you just need to hold on to your property for long enough.
As with any major investment, it’s important to calculate all costs carefully and consider your unique situation. For instance, you might need to consider the age of your property and what kind of repairs or renovations it might need in the future.
Understanding how negative gearing works is a critical factor in investing in property wisely and maximising the potential return on your investment. Discover more about property investing here. We also recommend speaking to a trusted financial advisor, and getting in touch with one of our team members for more information.