Positive versus Negative Gearing

Recently I was asked the question whether it was better to have a positive or negatively geared investment property.

To answer this question, we first need to have a clear understanding of the above terms.

Positive Gearing

Positive gearing is where the rental income is more than the properties outgoings. Outgoings may include interest payments, repairs, strata fees and rates.

Benefits of positive gearing include:

• The property will generate a positive cashflow;
  • The net positive cashflow can assist in paying off your bad debt such as the mortgage on your Principal place of residence. Surplus cash can also assist in developing your property portfolio by using the extra cashflow for a deposit towards another investment.

 

• Your purchasing power will increase;
  • The net income generated by the property will increase your income, which may assist in securing a loan for another investment property.

 

• Since the property is generating a positive net cash flow, there is less reliance on the property increasing in value or having capital growth.

One of the key potential negative aspects of positive gearing is that the net income generated from the investment property (rental income less outgoings) is treated as taxable income. Thus, the net income generated will add to your other income, such as wages or business earnings, and may result in you paying further income tax when your tax return is prepared.

We should note, that for tax purposes, only the interest charged on the investment loan is treated as an outgoing, not the whole mortgage repayment.

Its also important to note that there are strategies that can be implemented to reduce the income tax burden. One strategy is for a depreciation report to be prepared. Allowable depreciation may include that of the house/dwelling/building. This is often called a non-cash deduction, as it does not involve a regular cash outlay. A depreciation report can be provided by a quantity surveyor and will outline the potential yearly depreciation claims for a specific property.

Negative Gearing

Negative gearing is where the outgoings are more than the rental income. This generally occurs where an investor has borrowed money to purchase an investment property.

Benefits of negative gearing include:

• The main advantage is that the property will result in an annual tax benefit;
  • The net loss of the investment property can be claimed against your other taxable income. Thus, when preparing your tax return, it will reduce the amount of tax you need to pay, and may boost your tax refund.
    • The higher your other taxable income, the higher the tax benefit will be.

 

• Commonly, properties that are negatively geared experience long term capital growth. That is, the value of the property increases over time.

There are some key aspects of negative gearing that should be taken into consideration. These are:

• Due to the outgoings exceeding the income, you will need to contribute personal funds towards property expenses. Thus, it is important to incorporate surplus funds into your spending budget to allow for this;

 

• As mentioned above, a key aspect of negative gearing a property is for the property to have capital growth. Thus, when choosing a property to negative gear, it is important to choose a location that has a strong capital growth potential.

 

Conclusion

Whether it is better for a property to be positive or negatively geared is dependant on many factors including the following:

• Your level of other taxable income
  • The more your other taxable income is, the higher the tax benefit will be if the property is negatively geared. Conversely, if the property is positively geared, the tax on the net profit each year will be more.

 

• The purpose of purchasing the property;
  • Whether the property was purchased as:
    • a long term investment property
    • Rented out for a short term before being made your Principal place of residence;
    • Whether the property has development potential.

 

• The age of the property;
  • The more recent the property was built, the more potential for building depreciation claims;

 

It should be noted that it is possible, and not uncommon, to have a negative geared property with a positive cash flow. This can be made possible by the use of depreciation, which as mentioned above, is a non-cash deduction that may make the property negatively geared for tax purposes.

If you are interested in property investing, or have any questions regarding the above, please do not hesitate to contact me.