Negative gearing

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

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.

 

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