Negative gearing is a government incentive that supports the rental property market by providing a financial cushion for investors. In essence, it helps offset the costs of owning rental properties, making real estate investment more feasible and encouraging the availability of rental housing in the market. With property prices rising and housing affordability decreasing, renting has become more common, and negative gearing works to support both the rental market and property investors.
What Exactly is Negative Gearing?
In simple terms, negative gearing occurs when the income from a rental property doesn’t cover its financing costs, such as loan interest. Technically, a “negatively geared” property is one where the rental income is lower than the interest repayments on the loan. However, the term is often used more broadly to describe government tax incentives available for such properties, which allow investors to claim tax deductions.
How Does Negative Gearing Work?
Negative gearing operates through tax deductions. As an investor, if you take out a loan to buy a property, you expect the rental income to offset or exceed your expenses. When the rental income doesn’t cover your interest payments, you’re losing money. Negative gearing allows you to claim this shortfall on your annual tax return, helping offset the costs.
Example: Let’s say an investor takes out a $500,000 loan to buy a $600,000 property at a 5% interest rate. After one year, the loan balance with interest would be $525,000. If the investor rents the property at $400/week, they’d make $20,800 annually. Paying this amount into the loan would leave them with a balance of $504,200, still higher than the original amount before interest. This shortfall, simplified here, qualifies as a negative gearing loss, and the investor can claim around $4,200 as a tax deduction.
Benefits of Negative Gearing
This tax incentive is designed for investors—those who purchase property to generate profit, not for personal use. The idea behind negative gearing is to make real estate investment more viable, allowing property owners to recoup part of their losses on negatively geared properties through tax returns. While this may look like a neutral financial situation, it actually helps investors generate unrealized profit as the property appreciates.
Example: If that $600,000 property appreciates to $610,000 by the year’s end, the investor would have made a theoretical gain of $10,000. This is considered “unrealized” profit because it’s not available as liquid cash; it’s tied up in the property and only becomes “realized” profit once the property is sold.
Should You Consider Negative Gearing?
Negative gearing can be a valuable tool for investors looking to grow their property portfolios. However, understanding the nuances of tax law and the real estate market is essential. For further insights, check out our blog on tax exemptions for homebuyers.