negative gearing

Getting your head around Negative Gearing

There’s been a lot of talk in the media recently about a topic that looks set to be a key issue in the lead-up to the Federal election, and that topic is negative gearing. Now, whilst it is not our intention to start contributing to a political debate, we are finding that quite a few people aren’t all that sure what negative gearing is, or how it works. So here’s a bit of a summary.

What is negative gearing?

In most cases, negative gearing applies to someone who has borrowed money to purchase an investment property, but the interest on the loan is more than the income they receive in rent. This means that the investor makes a loss for a few years until they reduce their loan amount, or they increase the rent they receive.

Under current tax laws, this loss can then be deducted from other income, (in most cases the investors wage from their ‘day job’), reducing their overall taxable income in that financial year.

In contrast, positive gearing is what happens when the interest on the loan is lower than the net rental income. In this case the investor is liable to pay tax on this income at their marginal tax rate.

Why do investors use negative gearing?

Obviously, a property investor’s aim is to make money from their rental property in the long term. The idea is that any losses will be short term and outweighed by long-term capital gains. A landlord normally expects rental income to increase over time as the property rises in value and inflation plays its part. A negatively geared property normally becomes positively geared as time goes by.

The debate on negative gearing

As we approach the federal election, you can expect the volume on the debate about negative gearing to go up a notch or two. Whilst the full details of the Labor party’s policy are yet to be fully laid out, they have made clear that they plan to cut back on the ability of property investors to use negative gearing as a means of getting their foot in the property market. Some people think this will improve affordability levels for those first home buyers who are struggling to buy their first home, while others are less sure about this. Some are concerned about setting a precedent that actively discourages Australians from securing their own long-term retirement plans by setting the barriers too high for first time investors. We’ll leave you to make up your own mind on what this may mean.

Important questions on negative gearing

No matter what your political beliefs or financial position, there are two important questions that we think need to be answered as this debate moves forward, and we hope to see some answers before the vote takes place.

  1. Why should property investors be treated differently from every other profit-making venture which can claim its interest costs as a deductable business expense?
  2. If we are going to discourage Australian ‘mums and dads’ from becoming property investors, who is going to provide all the rental accommodation that our growing population will need? After all, if rents go up in the face of a shortage of available rental properties, that will actually make it harder for them to save a deposit for their first home, not easier.

As always, if you have any questions about the property market in general or your property in particular, don’t hesitate to give one of the team at Ian Reid Vendor Advocates a call. You might also like to download a copy of our free booklet, Fatal Real Estate Traps Exposed, while you’re here.