What is negative gearing and how can it benefit property investors?

Negative gearing is a common term associated with investment properties in Australia. It refers to a situation where the expenses incurred in owning and operating an investment property exceed the returns generated from it. So what is the concept of negative gearing and its implications?

Key Points

• Negative gearing allows property owners to offset costs against taxable income.
• Pros: can reduces rental costs, attracts buyers with tax benefits, increases housing value.
• Cons: initial losses, limited ability to acquire more properties.

Negative gearing occurs when the expenses of an investment property exceed the returns generated from it. Conversely, positive gearing occurs when the rental income covers all costs, including loan interest.

While the purpose of investing in properties is to make profits, negative gearing does not necessarily discourage investors.

The methodology of negative gearing

Maxwell Shifman, Chief Operating Officer at Intrapac Property, explains negative gearing as a method available to Australian taxpayers who own investment properties.

It allows them to offset the costs associated with the property against their taxable income.

Under Australian tax law, investors can claim the interest on their loan repayments as a tax deduction if the property is rented out or available for rent.

If, in fact, the total costs are greater than the amount that you’ve earned, then you can actually use those additional costs to offset your normal income from your work or any sort of other income that you might have.

Maxwell Shifman, Chief Operating Officer, Intrapac Property

Mr. Shifman says that negative gearing is more of an investment or tax deferral rather than a tax reduction.

Pros and cons of negative gearing

Negative gearing, like any investment strategy, has its advantages and disadvantages.

One of the biggest benefits is that it can reduce rental costs for landlords by allowing them to decrease their taxable income.

Additionally, it can attract buyers interested in negatively geared properties due to the available tax benefits, thereby increasing the value of housing.

Negative gearing encourages investment in property to meet rental demands and prevent housing affordability issues.

On the other hand, negative gearing can result in losses during the initial years of owning a property.

Peter Koulizos is the Program Director of the Master of Property degree at the University of Adelaide.

Negative gearing can also limit an investor's ability to acquire additional properties due to its impact on serviceability, according to Mr Koulizos.

If they negatively gear the wrong property, say a brand new apartment which doesn’t have much capital growth. Not only are they losing money week-to-week, but also there’s no capital growth, or very limited capital growth. So, they make a capital loss as well.

Peter Koulizos, Program Director of the Master of Property degree, University of Adelaide.

Negative gearing can reduce rental costs for landlords and attract buyers due to tax benefits.

The impact on the rental housing market

Stephen Mickenberger, Group Executive of Financial Services and Chief Commentator at Canstar, explains how negative gearing impacts the rental housing market.

He says that the government allows negative gearing to encourage investment in residential property and ensure an adequate supply of rental properties.

The government allows negative gearing to encourage people to invest in property, specifically in residential property, to make sure that there is a supply of property available to meet rental demands.

Stephen Mickenberger, Group Executive of Financial Services and Chief Commentator at Canstar.

If negative gearing is scrapped, it could lead to higher rents and rental shortages.

The Long-Term Benefits of Property Investment

Peter Koulizos says negative gearing is a trade-off that investors make to potentially profit from capital gains when selling the property in the future, despite initial losses.

Investing in properties allows people to build long-term wealth and reduces reliance on government pensions and retirement support, Mr Koulizos adds.

"Even if you own that one investment property worth $500,000 and you eventually have paid that off, you probably won’t be eligible for the old age pension or if you are, you’ll only get a portion of it. Therefore, they are less of a burden on the government coffers.”

The Australian financial year ends on June 30, and tax returns for the previous financial year must be filed between July 1 and October 31.