Negative Gearing & Positive Gearing

An introduction to the concepts of positive and negative gearing an investment property...

Gearing is an accounting strategy applied to real estate and property investment. The main aim of gearing is to get the most tax effective returns possible during your ownership or when the property is sold.

Negative Gearing:

The concept of negative gearing involves using a loan to purchase a property and then renting that property out to make an income. It is considered negatively geared when the income generated from the rental does not actually cover the costs associated with running the property and the interest on the loan used to purchase it. However this is not necessarily a bad thing because any losses incurred during this process are tax deductible, which in turn brings down your tax bill and boosts returns. The profit occurs when the value of the property goes up over time, resulting in capital gains outweighing the losses incurred during the negative renting period.

The savvy investor can leverage this process in such a way that they end up better off than if the property was making a small income, because that income would be taxed. Ask your accountant about calculating various loan to income ratios that determine if negative gearing will prove to be more profitable than positive gearing in your circumstances.

Positive Gearing:

Positive gearing is when an investor uses a loan to buy a property and rents it out, with the income exceeding the interest on the initial loan and running expenses. Positive gearing is beneficial when the income after tax coupled with the sale value of the house is more than if the investor used tax breaks from a loss of income. Most investors should aim to be positively geared in the long run. It is rare for somebody to make big capital gains and be highly geared. The idea is that if the housing market is booming negative gearing works, but if you’re unlikely to make high capital gains then you are more likely to get a good rental profit. It all depends on the economy, interest rates and the housing market and more. All of this needs to be considered and discussed with your accountant when making your calculations and taking out the initial loan.

History:

The idea of negative gearing and its tax benefits was introduced by the government to increase the amount of rental property available for people who were unable to purchase their own homes. This all subsequently led to a rise in property investment and development, which had a positive effect on the overall growth of the Australian property markets.