Negative gearing

An easy way to profit from residential property or a fashionable way to lose money?
Learn more
  • Updated:7 Jan 2006

01 .Introduction

Negative gearing is being promoted as an easy way small investors can make money from the property market.

This report investigates whether these negative gearing claims are too good to be true and what negative gearing really involves.

How are CHOICE tests different? We buy all the products we test – we don’t accept industry freebies and we don’t take ads. We're non-profit and our work is funded by people like you.

Please note: this information was current as of January 2006 but is still a useful guide to today's market.

What is negative gearing?

  • An investment is negatively geared when the costs you can claim from it on your tax return exceed the income it provides. In other words, it’s costing you money in that year, even with a tax break.
  • Although negative gearing is commonly associated with rental property, it can be used for other types of income-producing investment (for example, managed funds and shares).
  • Buying a negatively geared property is like buying a loss-making business. Make sure it’s the right strategy for you before going ahead — evaluate the investment’s likelihood of strong capital growth first, not just the tax breaks.
  • Negative gearing has substantial risks — your investment’s value may not grow sufficiently to cover your costs and give a good return.

What you'll get in this report

  • How it works: A costed example of how negative gearing works.
  • Common traps and our advice: Negative gearing is a risky strategy. Read our advice before you sign anything!
  • Property vs shares comparison: We compare investment returns with the growth of house prices over 10 years.
  • A case study of one couple’s negative experience with investment in the property market.

Sign up to our free

Receive FREE email updates of our latest tests, consumer news and CHOICE marketing promotions.


Using simple numbers, let’s say John, who earns $90,000 per year:

  • Borrows $450,000 to buy an investment property.
  • Pays interest at 8% per year to the bank (interest-only loan), incurring a total interest cost in the first year of $36,000.
  • His net rental income for the year, after other expenses such as agents’ fees, council rates, land tax, repairs, maintenance, building insurance and other allowable expenses, is $15,000.

Because John’s net income from the property ($15,000) is less than his interest expenses ($36,000), he has to find a way to meet the shortfall and pay the bank from his other income (probably his salary). But, in addition, negative gearing allows John to offset his net loss ($21,000) against his income tax.

Although investing in a negatively geared property leaves John with a lower overall net income for the year, the tax breaks from negative gearing mean his income tax bill is also lower. Table 1, below, sets this out as an overview.

John's negative gearing example
No investment
property ($)
With investment
property ($)
Salary (gross) 90,000 90,000
Net loss from property Not applicable 21,000
Assessable income (A) 90,000 69,000
Tax payable (B) 25,200 17,085
Net income 64,800 51,915
Difference in annual tax paid 8115 less with negative gearing
Difference in take-home pay 12,885 worse off with negative gearing

Table notes

(A) For simplicity we assume John has no other tax deductions.
(B) Calculated using 2006 – 7 income tax rates including the Medicare levy.

03.Why set out to lose money?


When you negatively gear, you’re accepting losses for a while in the expectation that eventually your income will exceed your costs (so you’ll be positively geared) and, more importantly, that your investment will increase in value so you can sell it for a capital gain in the future.

With direct property, investors hope to make money from:

  • Income — when the rent you receive exceeds your expenses (mortgage interest, maintenance costs, agents’ fees, etc).
  • Capital gains— the property appreciates in value over time and you sell for a profit (reduced by capital gains tax (CGT) at your normal marginal income tax rate, which is reduced by half if you keep the property for at least a year).

Of course, most investors would like the best of both worlds — rents that cover all their expenses and provide extra income, and a property that increases in value, giving the option to sell for a capital gain later.

However, you can’t always have your cake and eat it, particularly if property prices are high and rents are relatively low when you invest. Some properties may give a positive cash flow or a capital gain, but not both.

For example, a property in a regional centre might give you high rents (compared to the property’s relatively low purchase price) but not increase much in value. A city unit might give you a low annual income (compared to your expenses and mortgage repayments), but good capital growth over time.

In the latter case, if you’re confident the property’s value will grow significantly, you might use negative gearing and offset your losses against your income tax, especially if you’re in a high tax bracket.

04.The traps and our advice


The traps

While some property investment companies (which may also be selling property) advocate the tax benefits of negative gearing, there are plenty of traps to be aware of.

  • Property values may not rise, meaning you can’t recoup your losses. There’s no guarantee that the property growth of recent times will continue.
  • Can you afford it? You have to fund property expenses and repayments from other income.
  • Taxes or laws may change. For example, the May 2006 Federal Budget changed the top income tax bracket from $95,000 to $150,000, meaning that fewer property investors will be able to claim tax deductions at the top marginal rate. This, as well as a reduction in the top rate from 47% to 45% (the second tier reduces from 42% to 40%), further reduces the tax benefits of negative gearing.

On the plus side, income tax cuts leave property investors (and others) with more after-tax income and a reduction in their Capital Gains Tax rate if they sell.

Our advice

For most people, negative gearing is a risky strategy, not to be entered into lightly. It’s only sustainable if you have enough income from other sources to cover your loan repayments and other expenses.

  • Make your decision based on the quality of the investment, not the tax breaks. Make sure the property you’re considering is fairly priced, and consider getting independent licensed financial advice about suggested investment and tax strategies before proceeding.
  • Don’t rely on a property company’s forecasts — if it’s also trying to sell you property, its advice, which isn’t regulated in the same way, or subject to the same rules as advice about other investments, can’t be considered independent.
  • Negative gearing is most advantageous to those paying income tax at the top rate and with a steady income (the Treasurer says that from 1 July 2006 less than 2% of taxpayers will pay tax at the top rate). The long-term objective is to convert income into a capital gain that’s taxed at a lower rate.
  • Risks can increase considerably if property prices don’t rise enough to cover your losses.
  • While negative gearing can reduce your income tax while you own the investment property, you’ll have to pay capital gains tax if you make a profit when you sell.
  • You should consider income protection insurance, to cover you against an unforeseen loss of earnings (premiums are generally tax deductible, depending on your circumstances). If you can’t maintain mortgage repayments you could lose the property.
  • Investing in property has drawbacks compared to other investments like shares and managed funds — for example, it requires a bigger outlay, it’s harder to sell your investment and investing in a single property concentrates your risk.
  • Positive gearing (where you make net gains and pay extra tax) may be the best strategy for most direct property investors. The risks are lower and any capital gain benefits are the same.

05.Deductions you can claim


The Australian Taxation Office (ATO) considers many rental expenses as allowable deductions, including:

  • Advertising for tenants.
  • Body corporate fees.
  • Council rates.
  • Cleaning.
  • Insurance.
  • Interest on loans (but not mortgage principal repayments).
  • Land tax.
  • Lease costs.
  • Property agent’s fees and commissions.
  • Quantity surveyor’s fees.
  • Repairs and maintenance.
  • Utility charges.

There are conditions with many of these deductions. For example, repair expenses you claim must relate directly to wear and tear or other damage resulting directly from renting out the property.

Capital expenses (such as the replacement of a fence or stove, improvements, renovations and extensions) aren’t deductible, though an annual depreciation amount relating to some may be. You may also be able to claim capital works deductions for some expenses if you become liable for Capital Gains Tax later.

Depreciation claims

One of the many tax deductions property investors can make is for wear and tear — on both the building and what’s inside it. However, a word of warning: according to theTax Institute of Australia, depreciation claims are a common source of dispute between the ATO and investors, and you may be asked to provide written justification for your depreciation claims.

More information

06.Property vs shares


We compared investment returns over the 10 years to 31 December 2005 with the growth of median house prices in capital cities over the same period. To compare the growth of houses with other investments on a like-for-like basis, we converted overall median house price changes to an annual compound percentage rate.

House price increases

According to Real Estate Institute of Australia (REIA) data, median house prices in all capital cities more than doubled in the decade ending December 2005.

  • In the 10 years to December 2005, median house prices in Adelaide, Melbourne and Perth increased by around 153% – converted to an annual compounding rate of growth, that’s around 9.7–9.8% per annum.
  • Ten-year growth figures for Sydney weren’t available, but over five years, median prices grew by 53%; that’s around 9% (compound growth) per annum.

Listed property outperforms

  • As the table shows, the best-performing investment we compared for the 10-year period was property — but not direct investment in residential property. Listed property trusts (LPTs) returned an annual average of 14.6% over the decade.
  • LPTs can be bought and sold on the Australian Stock Exchange through a stockbroker and allow you to put your money into companies that invest in commercial properties.
  • Compared to direct property, LPTs offer more liquidity (you can sell the investment faster if you need to), lower transaction costs, more diversification (all your money isn’t stuck in one investment) and require less money to get started.

Caution – past performance figures

  • Past performance figures don’t indicate what’ll happen in the future:
  • Whether Australian property or shares continue their impressive growth rate over the next decade is highly uncertain.
  • When comparing these returns, remember 10 years is a relatively short timeframe for investments.;
  • Since 1995 we’ve seen a property bubble and a share market boom. The last decade may give you an over-optimistic impression of how investments and house prices may change.
Investment growth to end 2005
Returns / growth 10 years
(% pa)
5 years
(% pa)
3 years
(% pa)
1 year
Australian bonds (A) 7.4 6.0 5.3 5.8
Australian shares (B) 12.3 12.7 21.7 22.8
Small company shares (C) 9.9 13.1 26.1 19.6
Property trusts (D) 14.6 15.7 17.3 12.5
International shares (E) 7.1 –3.6 8.4 16.8
International bonds (F) 8.2 8.4 7.4 6.8
Growth of median house prices to December 2005 (G)
Adelaide 9.8 15.1 13.3 2.6
Brisbane 9.0 16.1 15.3 1.6
Canberra 9.0 14.5 14.4 5.1
Darwin 7.4 12.8 16.4 26.2
Hobart 9.7 19.2 23.4 4.3
Melbourne 9.7 6.8 3.8 1.4
Perth 9.8 15.5 18.7 18.2
Sydney (H) 9.0 2.1 -5.1

Table notes

Our calculations for property trusts, shares, small companies and bonds are based on data provided by Morningstar, for the period ended 31 December 2005.

The house price figures don’t include rents received from investment properties, just the growth in value. Figures for other investment returns include income received — for example dividends for shares — which is assumed to be reinvested.

(A) Composite 0+ years Index.
(B) S&P/ASX 200 Accumulation Index.
(C) S&P/ASX Small Ordinaries Accumulation Index.
(D) S&P/ASX 300 Property Truse Accumulation Index.
(E) MSCI World ex-Australia Net Dividends reinvested Index.
(F) Lehman Brothers Global Aggregate Index Hedged.
(G) Our calculations for median house price increases are based on Real Estate Institute of Australia data, for the period ended 31 December 2005. To compare with investments, we converted overall house price growth into an annual compounding rate.
(H) Comparable 10-year data not available.

07.Case study: sales job

Bob and Kaye bought residential investment properties some years ago, through a company that advocated negative gearing for tax savings and capital gains.

“We were flown to Brisbane at a very cheap fare, met at the ‘Golden Wing’ at the airport and taken to the company’s office,” Bob says. “A consultant gave us an analysis and projections of the benefits of owning rental property, mainly based on tax savings and capital gains. It essentially promised high rewards, limited risk and little effort. The salesman’s major selling point was reduction of taxation through negative gearing.”

Bob and Kaye were taken to see town house complexes in two locations. Bob’s suspicions about the value of one of the properties were aroused when he read the valuer’s report, which the company provided. “The report concluded that the property was ‘of the type that has been successfully marketed to the residential negative gearing market rather than local owner occupiers’.”

After some pressure and despite the warning signs, Bob and Kaye agreed to buy a property in each of the locations they were shown. “We were next hustled to a lawyer chosen by the company, but supposedly acting on our behalf, to sign the contract documents. Next, bank loans were arranged, again through the company.”

According to Bob, over the next three years it became apparent that one of the properties had been worth far less than they paid for it, with similar houses in the same area selling for less. Revaluations after three years showed it was worth $25,000 less than they’d paid, while the second property had shown a small increase in value. Bob says he decided they had been targeted by ‘two-tier marketing’ – a sales practice where out-of-town investors are sold property at higher prices than locals would pay.

Fortunately both properties have been occupied by tenants for most of the time, with rents growing regularly. But more importantly, Brisbane’s subsequent property boom has helped make up for the above-market prices Bob and Kaye think they paid.

Investors who pay over the odds and negatively gear into a slower property market (or who sell before a boom) mightn’t be so lucky.