Ultimate guide to negative gearing in Australia

Negative gearing is a common part of many investment strategies, but it can be misunderstood. This guide explains what negative gearing is, when it may be applied, and some risks you might need to be aware of.

Everyone’s situation is different, and the information in this article is general, so if you’re curious about how negative gearing could apply in your circumstances you should speak with a financial adviser or tax agent before deciding on a course of action.

When you borrow money in order to invest, it’s called gearing. Investments can be either positively or negatively geared. If an investment is positively geared, the income from the investment is more than the expenses associated with generating income from it.

If the investment is negatively geared, the expenses associated with generating income from the investment are greater than the income it generates. It means that, in the tax year, you have made a loss on your investment. The perceived benefit of this is that you might be able to offset this loss against other income, such as your salary.

While negative gearing in Australia is frequently associated with real estate (property investing) and home loan interest repayments, negative gearing may also apply to other types of investment and a wide range of expenses.

The cost of buying a property isn’t included in gearing calculations, so when you repay your loan principal, your repayments aren’t claimable as a tax deduction. However, the interest paid on a loan is included in gearing calculations and it can be an allowable tax deduction in certain circumstances (the mortgage interest tax deduction).

Investment loan interest is just one type of expense you may incur when generating an income from an investment property. For instance, you may also have costs to pay to maintain and repair the property, or body corporate fees. These costs may affect your gearing calculations, and if you take out loans to fund any of these expenses, the interest on those loans may also have an impact on gearing calculations.

Similarly, interest from other kinds of loans may impact negative gearing. For example, if you take out a personal loan to buy shares or a business, the interest from such a loan may be included in the gearing calculations.

Negative gearing is neither good nor bad. Whether it’s helpful for you can depend on your circumstances.

Some investments may be negatively geared in the short term, but the investor makes the property purchase anyway because they believe the investment will generate a good return down the track – they’re hoping for good capital growth. An example could be an investor buying an unprofitable business that they believe they can overhaul so it’s lucrative in the future. Similarly, when an investment property is negatively geared, an investor may be hoping to renovate the property and then sell it for a profit (this is often called property flipping).

Some investors may intentionally negatively gear their investment in an attempt to gain a tax advantage. In Australia, property investors sometimes negatively gear their rental properties because they may be able to gain a tax advantage while they own the property and believe they could potentially make a profit if they sell the property for more than they paid for it.

Of course, if you negatively gear an investment and it doesn’t turn a profit, even when you sell it, that means the investment could make a loss — and you could lose money.

A financial adviser or tax agent should be well placed to advise you whether negative gearing could be suitable for your circumstances.

Investing is often a risk versus reward decision, and there are several risks that are sometimes associated with negative gearing, here are some that could be helpful to be aware of.

• Taking out a home loan always comes with some risk because there’s a chance you might find yourself without sufficient cash flow and unable to make your repayments. This might be because your income has been affected, for example, or because of a rise in interest rates.
• There’s always a risk that the capital gains made when selling an investment may not be sufficient to cover the losses made from negative gearing – or you might even make a capital loss when you sell the investment.
• Choosing an investment based on tax benefits alone, which could cloud the judgement of the suitability of the investment.
• Failing to consider other tax implications, such as capital gains tax which is generally applied if you sell an investment for more than the original cost.
• Australian political parties periodically campaign for a change in legislation that look to restrict and reduce negative gearing tax deductions for investors. If such legislative changes were to become law, you may no longer be able to receive a tax benefit to help offset the impacts of negative gearing and, therefore, would need to make a far greater contribution or capital gain on a negatively geared investment.
• Some developers or property agents may sometimes try to sell sub-standard investment properties while touting the benefits of negative gearing.
• Margin lending is a type of gearing where the investment loan is secured by an asset such as shares. When you have a margin loan, the lender may make a margin call if the ratio of your loan balance to the value of your collateral grows to the point where it exceeds their threshold value (their maximum loan-to-value ratio or LVR). If your lender issues a margin call, you may need to either repay part of the loan to bring the LVR down to the lender’s threshold value, or offer additional assets as collateral for the loan. If you can’t do either of those things, you may have to sell part of your investment to repay part of the loan.

Tax and investing can be very complex, and it’s important to remember there are rules around what you can and can’t claim as a tax deduction.

There could also be other implications to your cash flow and investment that you should consider. Speak with a financial advisor and/or an accountant for information relevant to your own needs and circumstances.