Key Takeaways
- Borrowed asset costs exceed income, creating deductible loss.
- Loss offsets other taxable income, reducing tax bill.
- Profit depends on future capital growth.
- Common in property and share investments with loans.
What is Negative Gearing?
Negative gearing is a financial strategy where you borrow funds to acquire an income-producing asset, such as property or shares, but the income generated is less than the costs of ownership, resulting in a net loss. This loss can often be offset against other taxable income, reducing your overall tax liability while you aim for a capital gain when selling the asset.
This approach is commonly used in real estate investment but can also apply to shares, particularly when dividends are lower than interest expenses on margin loans.
Key Characteristics
Negative gearing involves distinct features that differentiate it from other investment strategies:
- Income vs. Expenses: Rental or dividend income is less than the combined costs of interest, maintenance, and depreciation.
- Tax Deductibility: Losses from negative gearing can be deducted against other income sources, such as your salary, reducing taxable income.
- Leverage: Borrowing (or facility) is essential to fund the investment, amplifying potential returns and risks.
- Cash Flow Impact: Requires out-of-pocket expenses to cover ongoing losses until the investment becomes positively geared or is sold.
How It Works
Negative gearing works by allowing you to use borrowed capital to invest in assets that generate less income than their holding costs. The shortfall creates a deductible loss, which you can offset against your other income, often leading to tax savings.
You typically sustain this position while holding the asset, expecting capital appreciation to eventually outweigh the accumulated losses. This strategy relies heavily on long-term market growth and tax policies that support loss offsets.
Examples and Use Cases
Negative gearing is prevalent in property and share investments, especially where tax benefits and long-term growth potential are favorable.
- Property Investors: Using a mortgage facility to acquire rental properties where rental income is less than expenses.
- Dividend Stocks: Investing in companies like dividend stocks where dividends do not cover margin loan interest.
- Corporate Examples: While not typical for airlines such as Pty, the principle of leveraging borrowed funds applies broadly across sectors.
Important Considerations
While negative gearing can provide tax advantages and potential capital gains, it carries risks such as cash flow strain and market volatility. You should assess your tolerance for ongoing losses and the impact of changes in interest rates or rental demand.
Understanding your position in the labor market and how fluctuations may affect your income and investment sustainability is crucial before adopting this strategy.
Final Words
Negative gearing can reduce your taxable income but requires careful cash flow management and a clear plan for capital growth. Run the numbers on potential losses versus expected gains before committing to ensure it aligns with your financial goals.
Frequently Asked Questions
Negative gearing is an investment strategy where the costs of owning an income-producing asset, like a rental property, exceed the income it generates. The resulting loss can be deducted from other income to reduce overall tax, with the aim of making a profit from future asset appreciation.
When your investment generates a loss, like when rental income is less than expenses, that loss can be offset against your other taxable income, such as your salary. This reduces the amount of tax you owe, providing immediate tax relief during the investment period.
Negative gearing typically applies to income-producing assets such as rental properties and shares purchased with borrowed funds. It can also apply to shares bought on margin loans if the dividends are less than the interest and other costs.
Investors accept short-term losses because they expect the asset’s value to increase over time, generating capital gains that outweigh the losses. Additionally, tax deductions on those losses reduce holding costs, improving long-term profitability.
Negative gearing means expenses exceed income, causing a loss that can reduce taxable income. Neutral gearing is when income equals expenses, breaking even with no tax benefit or loss. Positive gearing occurs when income exceeds expenses, resulting in a profit that is taxable.
Yes, if rental income rises, interest rates fall, or the loan is paid down, the investment can shift from generating a loss to producing positive cash flow, making it positively geared.
Profits come mainly from capital growth when you eventually sell the property for more than the purchase price plus the accumulated losses. Tax savings from deductible losses and potential future positive cash flow also contribute to overall returns.
Negative gearing can be advantageous for investors with sufficient income to benefit from tax deductions and a long-term investment horizon. However, it involves cash flow shortfalls and risks, so it's important to consider personal financial circumstances and investment goals.
