I’m often asked what negative gearing actually is. To those new to investing, the term can be confusing but in reality it’s quite a simple concept.
Negative gearing is where an investor borrows money to invest (this is the “gearing” bit), but the income generated by the investment is less than the interest and other costs to own and manage the investment, resulting in a loss (this is the “negative” bit).
The loss is tax deductible, thus reducing the overall amount of tax the investor pays.
A person borrows $400,000 to buy a property.
He receives $20,000 in rent for the year,
but pays out $24,000 in interest,
and $3,000 in other costs like land rates and insurance.
The net loss is $7,000, ($20,000 income less $27,000 expenses),
which reduces his taxable income, so the real after tax cost is only $3,745 assuming a tax rate of 46.5%
It’s important to remember that you shouldn’t invest in anything just for the tax break. Negative gearing still costs you money, even after the tax deduction, so the investment must make a capital gain over time that is more than what it has cost you to hold it.
The longer the investment is held the more likely this is to occur, so negative gearing should never be considered a short term strategy. I like to see a time horizon of at least 10 years before negative gearing is considered as an investment strategy.
- Related articles:
- What You Need to Know When Buying an Investment Property
- Why It’s a Good Time to Restructure Your Loan
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