Gearing in property investment is a term frequently discussed among investors, often in the context of whether an investment is positively or negatively geared. But what exactly do these terms mean, and how do they impact your investment strategy? Let’s delve into the concepts of negative and positive gearing, explore their benefits and tax implications, and consider which option may be best suited to your financial goals.
What is Gearing?
Gearing refers to borrowing money to invest, commonly associated with investment properties. It centres upon the income earned from your property investment and whether it exceeds or falls short of the expenses associated with property ownership.
Understanding Positive Gearing
A property is positively geared when the rental income surpasses the interest repayments and other property-related expenses, such as state levies and council rates. This surplus income can bolster your cash flow, providing another income stream. However, it’s important to note that the net rental income from a positively geared property is subject to income tax.
Negative Gearing Demystified
Conversely, negative gearing occurs when the expenses associated with owning an investment property exceed the income generated from it. These expenses typically include mortgage interest payments, property maintenance costs, insurance, and property management fees. When the rental income falls short of covering these expenses, investors are left with a net loss, which can be offset against other taxable income, such as salary, reducing taxable income and potentially lowering tax liabilities.
Let’s break down negative gearing further, delving into the pros and cons of this strategy:
The Pros of Negative Gearing
Tax Benefits
One of the primary advantages of negative gearing is its potential to reduce taxable income. Investors can claim the losses incurred from their investment property against their total taxable income, thereby reducing the amount of tax payable. Expenses eligible for tax deductions include the interest portion of loan repayments and certain other rental expenses, provided the property is rented or available for rent.
Long-term Capital Growth
While negative gearing may result in short-term losses, many investors view it as a strategy for long-term capital growth. Over time, property values may appreciate, potentially yielding substantial gains when the property is sold.
Asset Accumulation
Negative gearing allow investors to acquire property assets with relatively little outlay. The ability to leverage borrowed funds enables investors to build a diversified property portfolio and accumulate wealth overtime.
The Cons of Negative Gearing
Cash Flow Constraints
Negative gearing relies on investors having sufficient cash flow to cover the ongoing expenses associated with the investment property. In periods of vacancy or rising interest rates, investors may find themselves facing financial strain.
Risks in Market Downturns
Property markets tend to be inherently cyclical, and periods of economic downturn can impact property values and rental demand. Investors relying on negative gearing may face increased financial pressure during market downturns.
Strategies for Successful Negative Gearing
Property Selection
Choose investment properties with strong rental potential and the prospect for capital growth. Conduct thorough research into local market conditions, rental yields, and vacancy rates to identify properties that align with your investment goals.
Cash Flow Management
Implement effective cash flow management strategies to ensure you can meet the ongoing expenses of your investment property, even during periods of vacancy or financial instability.
Long-term Perspective
Take a long-term view of your investment strategy and be prepared to weather short-term fluctuations in property markets. Diversify your investment portfolio to mitigate risk and maximise potential returns overtime.
Tax Consideration and Capital Gains Tax
Both positive and negative gearing strategies have tax implications. While positively geared properties generate taxable rental income, negatively geared properties allow investors to offset rental losses against other income, thereby reducing tax obligations. Additionally, capital tax gains (CGT) applies when selling an investment property, with the amount of tax dependent on various factors, including the duration of ownership and applicable discounts.
Rental Income and Deductions, 2016 to 2021
Choosing the Right Approach for You
Deciding between positive and negative gearing depends on individual circumstances, financial goals and risk tolerance. Our property investment specialist team at Westcoast Property Invest can help provide personalised guidance tailored to your specific situation. Additionally, familiarising yourself with the Australian Tax Office (ATO) guidelines on rental property deductions and CGT can help inform your decision-making process.
Making Informed Investment Decisions
In the realm of property investment, understanding the nuances of gearing strategies is crucial for making informed decisions. Whether opting for positive or negative gearing, it’s essential to consider the potential benefits, tax implications, and long-term financial objectives. By seeking professional advice and staying informed about taxation laws and regulations, investors can navigate the complexities of gearing strategies and maximise their investment outcomes. Remember, each investor’s journey is unique, and tailored guidance can help unlock the full potential of your investment portfolio.
*The content of this blog is provided for informational purposes only and should not be considered financial or investment advice. It is recommended to consult with a qualified financial advisor before making any investment decisions.
References
https://www.commbank.com.au/articles/property/what-is-negative-gearing.html
