Negative gearing has become a common strategy for young professionals looking to break into the property market. By using negative gearing, property investors can offset some of the costs of owning a rental property against their taxable income when the property operates at a loss, making it easier to manage mortgage payments. This can be particularly beneficial for those with higher incomes and substantial tax liabilities.

The primary benefit of negative gearing is the ability to reduce your taxable income by claiming the losses incurred on a rental property. For young professionals, this means that while the rental income may not cover the mortgage in the short term, the tax deductions help ease the financial burden.

If you're considering using negative gearing as a way to enter the property market, it’s essential to understand the financial implications and how it fits with your tax situation. Schedule a complimentary consultation to explore how negative gearing could work for you.

How does negative gearing work?

Negative gearing is a popular investment strategy for young professionals trying to get into the property market as it provides a way to access additional cashflow to help service a mortage on rental properties that initially make a loss.

Negatively gearing a rental property occurs when the costs of owning the investment, specifically the interest incurred on the mortgage, exceed the income generated by the asset, resulting in a net rental loss. The resulting loss can be offset against other income, such as the property investor's salary, to reduce their own taxable income.

In this way negative gearing encourages property investing in rental properties that don't produce an immediate profit in the short term due to the net rental income not being enough to cover the interest on the mortgage repayments.

Why do people invest in property that makes a loss?

It may seem counterintuitive that many Australians knowingly purchase investment properties that operate at a loss. There are two main reasons that investors make property investments in real estate when those assets aren't able to generate a profit in the short term:

Capital gain

Investors purchase negatively geared investment properties in the hope that they will realise a capital gain when they sell the property in the future, which is expected to more than make up for the loss.

Capital Gains Tax will likely be triggered in the event that the investment property is sold and needs to be factored into the profits the investor expects to make. There are ways people can legally reduce their Capital Gains Tax, mainly through the Principle Place of Residence. For more information, see our article How the "6-Year Rule" can reduce your Capital Gains Tax (CGT).

Positively geared property

Investors may also hold the property for long enough that it ceases to make a net rental loss on the rental income earned and becomes positively geared. For more on positive gearing, see below.

Positive gearing vs negative gearing

Positive gearing is the opposite of negative gearing. A positively geared asset occurs when the income generated from the investment, such as rental income from an investment property, exceeds the costs associated with owning and maintaining that investment. In this scenario, the investor not only covers their expenses incurred as a result of holding the asset, they also earn a profit, which can contribute to their overall income.

While positive gearing means you'll pay tax on the additional income generated by the investment property, it also provides a steady cash flow and reduces the reliance on capital growth to make the investment worthwhile. This strategy can be attractive for those seeking immediate returns rather than long-term capital gains.

What is needed for negatively gearing an investment property?

Adequate rental income and adequate personal income to cashflow the repayments

While negative gearing inherently involves making a loss, having sufficient rental income is still crucial. The rent should cover a significant portion of your rental expenses, such as mortgage repayments, maintenance, insurance, and property management fees. This helps ensure the property isn't a drain on your finances and maintains a manageable cash flow. Even though the property is negatively geared, having steady rental income minimises the financial strain and helps sustain the investment over time.

Remember, you only negatively gear the interest repayments, so you may still need to fund some of the loss out of your own personal income, which is why it's important you calculate how much you should expect the asset to generate in terms of rental income and how much you will need to personally cover if there's a remaining amount that can't be offset by negative gearing.

Tax liability

One of the primary benefits of negative gearing is the ability to offset the losses from your investment against your taxable income. To maximise this advantage, you need to have a sufficient tax liability—meaning you earn enough income from other sources, like your salary, to make the tax deductions worthwhile. The losses from the negatively geared property can then reduce your overall income tax payable, potentially leading to a lower tax bill.

Professional Advice

Negative gearing is a complex financial strategy that can have significant long-term implications. A good chartered accountant can help you understand the tax benefits, assess the potential risks, and ensure that you’re structuring your investment in a way that optimises your tax position. They can also help you navigate any changes in tax laws or regulations that might affect the viability of negative gearing.

Next Steps

If you're considering purchasing an investment property and need assistance calculating how much you can negatively gear using your tax liability, and how much of the shortfall you will have to cover out of your own cash flow, reach out to us today.

To learn more about the tax deductions available for investment properties, read our articles Understanding Australian investment property tax deductions: What every property investor should know, and Understanding Australia's Investment Property Tax: Benefits, Costs, and Key Considerations.