A Simple Explanation Concerning Negative Gearing on Rental Properties

The term “negative gearing” is often discussed in a wide manner of forums but often, there can be a great deal of misunderstanding and misinformation on the topic. The term itself sounds like a phrase straight out of the dictionary of a merchant banker. Further, in recent years, the concept has gained a reputation, with some, as a device that gives people an unfair advantage.

Let’s take a “clinical” look at the issue and hopefully remain agnostic in the process. First; negative gearing can apply to any investment that is purchased using a loan. It’s not the sole domain of a rental property. Negative gearing can apply to shares in companies (whether they are private or listed on the stock exchange), units in a unit trust or equity in a sole trader or partnership business.

Second; the essential two elements for negative gearing are (1) an investment (that generates income) and (2) a loan to buy that investment. Gearing describe the origins of the money obtained to acquire the investment. If you use borrowed funds, your assets are said to be “geared” compared to one alternative of using your own savings to purchase the investment.

Under tax law, expenses incurred in the course of generating income are tax deductible. A typical rental property may incur expenses such as advertising for tenants, real estate agent management fees, council and water rates, land tax, insurance and repairs. In addition to these is another expense, and potentially the biggest, being interest on the loan to buy the property. In summary, interest is one of many deductible expenses relating to rental properties.

Where there is insufficient rent received on the property to cover all the deductible expenses, a rental property loss arises. Alternatively stated, the investment is producing negative income because of the interest on the loan). The rental property “loss” can be offset against other income. For individual investors, the loss can be offset against wages. This lowers a person’s taxable income and either results in a tax refund or reduces their tax payable.

As it is almost impossible to purchase an investment property without a loan, the tax deduction for the loan interest and consequent rental property tax loss helps to make the investment more achievable. Without it, the average income earner may never be able to invest in property.

The tax rules relating to rental properties can be complex and we recommend you obtain get professional tax assistance before committing to any property investment.

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