Is negative gearing a positive?


Negative gearing is when the costs of an investment are more than the income received from the investment. If you receive $20,000 a year in rent from a property but the interest charges on the mortgage, the rates and utilities and the insurance cost $20,001 than you have a negatively geared investment property. The following scenarios do no take into account depreciation, depreciation is a non-cash deduction and doesn't directly assist the prupose of this article as it is doesn't affect cashflow directly.

The effect is that if you earn $60,000 a year you should pay approximately $12,000 in tax. Once you add the rent to your income you pay tax on $80,000 but because of the expenses associated with the investment your taxable income is reduced by the cost of owning the investment (we're going to assume $35,000 in expenses for this scenario). 

$60,000+$20,000=$80,000

$80,000-$35,000=$45,000

You can instantly see that the owner has a taxable income of $45,000 compared to $60,000 when no negatively geared investment property was accounted for. A reduction in tax payable of a bit over $5,000. This sounds great in theory. The issue arises though when you consider that the owner has paid $15,000 to own the property and only saved $5,000 in tax. On the other side of the argument is positive gearing.

If you own an investment that receives $40,000 a year in rent and only costs $25,000 to own your taxable income increases by $15,000 which equates to an extra $5,000 in tax. People get scared of paying extra tax but you only pay tax on money you make so in this scenario the owner is still ahead by approximately $10,000 a year.

It is very important to stress that this is true for this scenario and in most similar situations it will ring true but it is important that if you are uncertain you speak to an accountant or financial adviser to ensure that this outcome is right for you especially if you're nearing retirement or purchasing in a Self-Managed Super Fund.

At the end of the day negative gearing is a great tool to use when purchasing an investment property but I would be careful of making investment decisions with negative gearing as a core part of your strategy unless advised by a qualified professional to do so.