When it comes to choosing any investment your timeline, goals, overall financial position, and risk tolerance should always be front of mind. Once you understand what your goals and motives are, considerations such as choosing a negative or positive geared property can then be considered.
Negative gearing explains the conditions in which the expenses from an investment, usually an investment property, exceed the income. It implies a loss by the traditional definition of net income as the income is less and expenses are more, and the net income is negative.
The income from an investment property consists of the rent, while the expenses constitute the cost of owning and managing the property, including the interest on the loan and depreciation. When the income generated from an investment property is not sufficient enough to cover the cost of owning the property, the property is said to be negatively geared.
Sometimes a property might be negatively geared in the eyes of the ATO but then from a cash flow position, it may be cashflow positive. There are various ways you could potentially achieve this such as capitalising on depreciation or utilising an offset account.
Positive gearing, on the other hand, is when you borrow money to buy an asset and the income from the asset is more than the expenses. Positive gearing implies constant regular income in the form of rent, in addition to the capital appreciation on the property. It also indicates that the demand for rental property is high, interest rates are low, and rents are on the higher side.
The income from positive gearing is taxable and subject to income tax at the marginal tax rate. Therefore, positive gearing does not help in providing tax benefits or reducing the taxable income. However, if you can manage to generate rent more than the expenses, the consistent income from the property can be beneficial in reducing the size of the loan as you pay down your mortgage as you go. It can also support your day-to-day expenses or your savings towards buying another property.
Overall, positive gearing suggests net profit on the investment, positive cash flow, and a combination of ongoing income and capital gains. It is usually applicable to properties in regional areas with slow capital growth and higher rents than property prices.
Negatively geared properties may sound counterintuitive because of the associated losses; however, it can have some advantages.
According to the tax laws in Australia, the losses incurred through the investment properties can be deducted from the total taxable income for the financial year. Therefore, the income from salary and wages can be reduced through negative gearing to lower the taxable income and pay fewer taxes. Also, the rental income added to the total income is lower, further reducing the taxable income.
Negative gearing is also advantageous when you eventually decide to sell the investment properties. If the property market is soaring, the investment property can be sold at a profit, and the rental losses incurred can be compensated with the capital gain. Some investors opt for negative gearing intentionally to benefit from the tax deductions and the eventual capital gains at the time of selling the property.
While both positive and negative geared properties have their pros and cons whether a property is positively or negatively geared shouldn’t be the motive behind your investment, considerations such as market performance, your timeline, goals and overall financial position should all be heavily considered and all built part of your investment strategy.
Speaking with our Credit Adviser Damien Mifsud he mentions,
“We often have clients approach us looking for negatively geared investment properties, in these cases we general question what their overall goals are. It’s more important to find the right property rather than choosing one solely based on its tax advantages.”
Both negative and positive gearing can work, depending upon your financial conditions and financial needs. While positive gearing works if you’re looking for regular and consistent rental income from your investment property, negative gearing is advantageous for capital appreciation and tax benefits.
“While tax benefits may be beneficial you also don’t want to see your investment constantly losing money. If they were constantly at a loss you would then be relying more on the growth of the property to help compensate you for those carried forward losses.”
It is important to consider that negative gearing, however attractive it sounds, requires the owner to also be in a stable financial position and can afford to cover the remaining cost after rent on the loan. Given current low-interest rates, it may also be harder to justify a negatively geared property and the rent would have to be dramatically lower than the overall loan to achieve this, you also need to consider repayments on your home loan if interest rates were to rise again. You should also have enough money set aside to fund the shortfall out of your own pockets until you sell the property and generate profit.
As always consider your other investments, entire financial position, goals and dreams to see which strategy is right for you. A Credit Adviser or Financial Planner will be able to assist you to make an informed decision and evaluate other areas of your finances to ensure your investments are working in your favour.
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What you need to know
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