In Australia’s booming property market, negative gearing is both a common investment strategy and a divisive political topic.  

But despite all its airtime, many Australians are unsure what negative gearing actually is and how it works from a tax perspective.  

In this article, we break down the fundamentals of negative gearing in simple terms, including its benefits, risks and key considerations. 

What does negative gearing mean? 

Negative gearing is a financial strategy in which the cost of maintaining an investment exceeds the profit made by the end of the financial year.  

If we’re talking about an investment property, the overall costs associated with managing the property – such as the mortgage interest rates, land tax, council rates, maintenance and management fees – may exceed the rental income. Essentially, this means you’re making a loss on your investment from a cash flow perspective.  

Using a negative gearing strategy, you can deduct these losses from your overall taxable income, potentially lowering your tax burden for that financial year. For many investors, the reduction in taxes they owe can offset some of the financial hit from the property’s negative cash flow. 

Generally, the goal is to benefit from capital growth over time, offsetting the short-term losses. 

How does negative gearing work? 

Let’s say you buy a property for $500,000 and earn a salary of $90,000 annually. Throughout the year, you pay $18,000 in interest and incur additional expenses for maintenance, management fees, rates and taxes, totalling $7,000. Meanwhile, your rental income from this property is only $20,000.   

This results in a loss of $5,000 because your expenses (totalled at $25,000) are more than your rental income. Using negative gearing, you can deduct this $5,000 loss from your taxable income of $90,000, reducing it to $85,000.  

This strategy lowers your tax liability for the year and sets you up for potential tax savings. While the property currently runs at a loss, you’re betting on its value increasing significantly over time, realising a gain on your investment if (or when) you choose to sell it. 

Benefits of negative gearing 

Negative gearing carries risk because it relies on market growth to realise an eventual gain on the asset.  Despite this risk, the short-term tax and cash flow benefits make it an appealing strategy for some property investors. Here’s a closer look at the pros of using negative gearing: 

Tax benefits to reduce your overall tax obligations: Deducting the losses incurred from investment properties could result in significant tax savings—this is especially advantageous if you’re in a higher tax bracket. 

Leveraging opportunities to expand your property portfolio: Using borrowed funds to buy properties, investors can broaden their investment portfolios without depleting personal capital. This could increase potential returns, especially if the property grows in value over time.  

Potential for capital growth: The Australian property market has a strong track record of long-term growth. This historical trend provides investors with the opportunity for substantial capital gains as property values increase over time. 

Rental income: While you might experience rental losses from negative gearing, you can still benefit from the rental income your property generates. This income can help cover ongoing expenses like property maintenance and mortgage payments, reducing your overall loss. 

Risks of negative gearing 

Whilst negative gearing is an attractive strategy for some, it’s essential to consider the potential risks associated with it as well:  

Cash flow risks: Negative gearing depends on future capital gains from selling the property to compensate for the annual rental losses. If your property’s value doesn’t increase (or if it decreases), you may risk extended periods of negative cash flow. 

Dependency on tax benefits: Negative gearing heavily depends on tax deductions, meaning that changes in tax legislation or policies could impact its variability as an investment strategy. 

High debt exposure: Negative gearing often involves borrowing which exposes you to risks associated with high debt levels, such as interest rate fluctuations and economic changes.  

Impact on affordability: There are concerns that negative gearing can drive up property prices, making it more difficult for first-time homebuyers to enter the market. This influence on housing affordability is a significant socio-economic issue. 

Risk of potential losses: There’s no guarantee that property values will rise, and relying solely on negative gearing for tax breaks and potential capital gains could lead to loss if market conditions don’t improve. 

Using negative gearing to reduce your taxable income? Here are 5 things to consider 

To make the most out of negative gearing as a strategy, it’s also important to have a handle on more specific tax-related considerations, such as depreciation, capital gains tax (CGT) and tax laws. Here are 5 key points you should consider: 

1. Tax deductions: As a property owner, you can reduce the tax you owe by deducting certain costs associated with running your property. This includes expenses like mortgage interest, fees for property management, and money spent on repairs and maintenance. 

2. When to deduct expenses: It’s important to know when you can deduct expenses. You can deduct regular expenses – like interest from your mortgage – each year, but costs for property improvements need to be spread out and deducted over several years (a process known as depreciation). 

3. Other expenses: Remember that other costs, like insurance, council rates and advertising costs for finding tenants, are also deductible. These can further lower your tax payments. 

4. Income tax offset: If your property’s expenses are greater than the rental income you earn, the difference may be subtracted from other income you earn, like your salary, reducing your total taxable income. 

5. Capital gains tax (CGT): If you sell your property and realise a gain in doing so, you’ll need to pay CGT. However, depending on how long you’ve held the property and how it was used, there may be tax concessions you can apply.   

Need help understanding if negative gearing is right for you? 

Chat with our team of accounting specialists 

For personalised guidance, please don’t hesitate to contact our team by completing an enquiry form, calling us on 03 5221 6399 or emailing via info@davidsons.com.au

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This article was written by Tax and Business Services Manager Michael Rebula.  

Disclaimer: The information provided in this article is factual in nature and objectively ascertainable and, therefore, does not constitute financial product advice. Importantly, the factual information that has been supplied does not take into account your personal circumstances, objectives or goals.