What is negative gearing?

Negative gearing is a form of finacial leverage where an investor uses borrowed money to secure an asset. It is usually applied to property purchases and sometimes shares or bonds. A property is negatively geared when the costs of owning it – interest on the loan, bank charges, maintenance, repairs and capital depreciation - exceed the income it produces. When your investment makes a loss you can claim a tax benefit. This is the essence of negative gearing.

You can also positively gear a property. This occurs when the investment income exceeds your interest expense (and other possible deductions). Note that you may be subject to additional tax on any income derived from a positively geared investment.

You’ve probably heard positive things about negative gearing (a loss making investment!) because of its potential to offer investors significant tax benefits. The primary benefit is the ability for an investor to reduce their tax liability on other income (perhaps wages, bonuses or dividends from stock market investments), thus reducing the overall amount of tax they pay.

Property investors can claim deductions and depreciation against income on the property in the three main classes of deductions including revenue deductions, claims for capital items and claims for building allowances.

Risks associated with negative gearing

There is an inherent risk associated with borrowing to fund an investment. While negative gearing can help you increase your gain on borrowed funds, in adverse circumstances the losses can be large. As a general rule, only investors with the financial capacity to wear the effect of potential falls in investment values or an increased cost in interest payments or maintenance should consider negative gearing. It is usually investors with healthy cash-flow who adopt a negative gearing strategy.
 
You can minimise the risks of negative gearing by:

• Choosing your investment property carefully for steady long-term capital gain
• Having sufficient income to cover increasing interest repayments or in the event that a tenant damages the property or the property is unrented for an extended period of time
• Taking out appropriate insurance, for example, landlord’s insurance.