What is Negative Gearing? Pros and Cons

Negative gearing – the term’s been thrown around a lot these past few years, but not many people seem to know what it means.

Negative gearing occurs when the income generated from your investment property is less than the expenses that go into running it. These include the cost of your home loan, mortgage, insurance, council rates, management fees, and more.

Before implementing a negative gearing strategy, it’s important to understand the risks and rewards involved:

Advantages of Negative Gearing

• Tax Deductions: Losses incurred from expenses can be deducted from your tax return, allowing you to lower your income tax each year. In some cases, the tax savings can outweigh the total net loss.
• Long Term Capital Growth: Your investment property has the potential to increase in value over time, especially if you purchase in a good location. You could even recoup your losses and earn significant profits if you decide to one day sell.
• Higher Demand from Low Rental Fees: By lowering your rental fees to ensure negative income, you can instill tenant loyalty, and should they decide to leave, you’ll have a bigger pool of tenants to choose from.
• High Depreciation: Like many things, a house can develop wear and tear over time, especially regarding walls, carpets, and lighting fixtures. Because your investment property is an income-producing asset, you can claim losses sustained through depreciation when it comes time to complete your tax return, saving you tax and improving cash flow in the long run.
• Opportunity for Future Development: A property that projects a positive cash flow might have the potential to be developed or converted into multiple properties, giving you a better rate of return than you would be buying a single positively geared property. If you have enough investment properties earning a loss greater than your income, you might end up paying zero tax.

Disadvantages of Negative Gearing

• Negative Cash Flow: Even with tax deductions, a loss is still a loss. Negative gearing can be a drain on your cash flow and might not suit those who don’t have a lot of cash to begin with or wish to create passive income. If you are highly negative geared, the costs can become too high even with the tax advantages, so keeping the property in the long term might not be sustainable.
• Capital Loss: The markets can be unpredictable, and although holding a property long-term can result in capital growth, you still have to pay for expenses out of your own pocket each month. You’ll also be completely reliant on capital gains.
• Limited Portfolio: Since your money is tied up in paying for expenses, you might not have the funds to grow your investment property portfolio or purchase other income-producing assets.
• No Tenants: If your tenant ends up moving out and your investment property remains vacant for too long, it might affect your cash flow. You might even end up losing your investment property altogether if you can’t make your loan repayments.
• Limited Number of Investments: Even though you have the opportunity to grow your portfolio, negative gearing can still limit the number of investment properties you can own. Whether you own 5 or 10 properties, you’re likely to run out of money at some point trying to fund all these investments, especially if cash flow is poor.

Before making any major financial decisions, potential investors should speak to a registered financial advisor to better understand negative gearing and whether it’s right for you.

At Blossom Accountants and Business Advisors, we’re ready to help to determine the potential benefits and shortcomings of negative gearing in light of your financial situation.