If you’re considering an investment strategy that includes property in Australia, one of the things worth understanding is the difference between negative and positive gearing, and the possible benefits and risks.
The term ‘gearing’ basically means borrowing money to invest - you can borrow to invest in a property, a business, shares or managed funds. We’re focusing on gearing property.
The income you earn from your investment property is either negatively or positively geared.
How does negative gearing work?
Negative gearing means the interest payments and other property-related costs you incur are higher than the rental income you receive from your investment property. Which means it’s likely you’re making an income loss.
Benefits and risks of negative gearing
The main benefit of negative gearing is that you can typically claim a tax deduction for the interest and other property-related costs of your investment property. This could reduce the overall tax you pay on your other income, such as your salary.
It’s important to remember that despite this potential tax benefit, if your property is negatively geared, you’re still making a loss. Generally, for negative gearing to be beneficial, the investment property needs to achieve capital growth – or rise in value – during the time you hold it, to more than offset the income losses you make along the way. You’ll also need to do your research and consider the capital gains tax implications if you sell.
Negative gearing can be a high-risk strategy, particularly if your situation changes, or interest rates rise, and you can’t cover the debt or loss easily.
How does positive gearing work?
Positive gearing is when the interest payments and other property-related costs you incur are lower than the rental income you receive from your investment property. This means you’ll be making money.
Benefits and risks of positive gearing
The main benefit of positive gearing is that you’ll typically have a surplus income amount each month. This can help you more confidently meet your loan repayments.
While the surplus income will be taxed at your marginal income tax rate, this is only the amount remaining after you have deducted the interest and other property-related costs associated with your investment property. Find out more about rental expenses you can claim as tax deductions from the ATO.
The risks of positive gearing generally relate to any kind of property investment. Some things to consider are:
- Will you have enough money to cover your loan repayments if the property becomes vacant?
- Do you have adequate savings to cover unexpected maintenance bills?
- Can you still comfortably pay the loan repayments if rental rates decline in your area or interest rates rise?
Which strategy is best for you?
Whether your property investment is negatively or positively geared will depend on your circumstances and financial goals.
Before considering any gearing strategy, it may help to speak to your financial adviser, so you understand more about the potential risks and benefits involved. If you don’t already have a financial adviser, you can find an adviser online.
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