Negative gearing is a form of financial leverage, where the funding costs exceed the income returns.
Two most common examples of negative gearing are:
- An investor borrows to invest in a residential rental property. The rent received is less than the interest on the mortgage.
- An investor borrows to buy shares (i.e. margin loan). The dividends income cannot cover the interest costs.
Investment losses from the negative gearing can offset other assessable income (i.e. wages). This has made negative gearing particularly attractive to those taxpayers at the top marginal tax rate due to the tax savings obtained.
However, negatively geared investment does not only give you a tax saving, it also gives you a debt. Margin calls especially during the GFC have caused investors great stress and cash flow problems.
The recent collapses of the tax driven forestry investments, like Timbercorp and Great Southern, also remind us that an investment should never be judged solely on the basis of the tax benefits obtained.
Furthermore, if the capital growth cannot cover the income losses accumulated over the years, the investment will only return an overall net loss when it is sold, because losses from income will reduce the profit from capital growth.
It is essential to analyse the rate of return and the sustainability of the long terms income before taking on more debt just for the tax benefits.
Liquidity should also be taken into account when deciding if negative gearing is suitable for you. Although negative gearing could reduce your tax bill, your investment is still returning cash losses. Do you have enough cash to cover the shortfall of the investment losses? What if the interest rate rises? What if the property is vacant for a sustained period of time? When will the investment start returning positive cash inflow?
As a start, gave a look at our Negative Gearing Calculator or give us a call to find out whether negative gearing investment property is right for you.