What is Negative Gearing?

Negative gearing is a form of financial leverage, where the funding costs exceed the income returns.

Two most common examples of negative gearing are:

1. An investor borrows to invest in a residential rental property. The rent received is less than the interest on the mortgage.

2. 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.

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Disclaimer:

The information provided in this article is general in nature and does not constitute personal financial, legal or tax advice. While every effort has been made to ensure the accuracy of this content at the time of publication, tax laws and regulations may change, and individual circumstances vary. Dolman Bateman accepts no responsibility or liability for any loss or damage incurred as a result of acting on or relying upon any of the information contained herein. You should seek professional advice tailored to your specific situation before making any financial or tax decision.