One of the most common questions investors ask is whether to negatively or positively gear an investment property.
The main difference between the two options is how it affects your taxable income. The right investment decision for any property investor will depend on their individual financial situation and goals.
So what's the difference?
Negative gearing means that the cost of owning an investment property outweighs the rental income it generates. Although you are making a loss, these losses are tax deductible and result in tax savings overall.
As an example, let's assume that your rental property earns $20,000 in one year and the expenses of owning the property (loan repayments, body corporate fees, maintenance, etc.) are $25,000. You will have a loss of $5,000 which you can claim as a tax deduction.
The biggest benefit of a negatively-geared property is the ability to claim tax deductions and reduce your taxable income.
Additionally, a negatively geared property investment may appreciate in value over time. This capital gain in the value of the home can offset your other losses.
There is also a risk involved with negative gearing because you are losing money. You will always need to budget for an ongoing shortfall and prepare for the losses.
Able to claim losses on the asset such as borrowing costs, building depreciation, and property expenses on tax to reduce your taxable income overall
Capital growth can outweigh losses
Requires strong enough cash flow to cover losses
Likely to have an annual cash shortfall until tax time when you can claim on tax
Depending on how highly geared your investment properties are you can be at risk of rising interest rates
Positive gearing occurs when the property is receiving more rental income from tenants than it costs to own and fund the property. This means you can profit from the investment from day one.
As an example, let's say that your investment property is earning $20,000 a year from rent, and your expenses (loan repayments, body corporate fees, maintenance, etc.) are only $15,000. You'll have positive annual cash-flow of $5,000.
Obviously, the benefit of a positively geared property is the income. You don't need to shell out any money from your salary for the expenses, and you can put your money elsewhere.
You're earning money from positive gearing, so this means you will pay more tax. The higher the income you generate, the higher your tax obligations will be.
However, many positively geared properties are located in outer or regional areas, so your property may experience slower capital growth.
The investment property will be generating rental income, which means you can save money towards a deposit for another property or pay off your existing mortgage repayments
In comparison to negative gearing, a positively geared property portfolio reduces your overall debt
Additional income can increase your borrowing capacity
Bigger tax obligations as you will be earning extra income
Can require long-term tenants to maximise the benefits
Potentially slower capital growth
To clearly understand the difference between negative gearing and positive gearing, the key differences have been highlighted in the table below.
|Positive gearing||Negative gearing|
|You’re making an ongoing net profit on the rental property||You’re making an ongoing net loss on the rental property - which can be offset against your taxable income|
|You have an extra cash flow which could go towards making extra repayments, renovations, savings, into an offset account, or even be used to buy another investment property||You need to have extra cash available to cover the net loss you’re making on the property|
|You may need to pay tax on your investment property's earnings||The net loss you’ve made could allow you to claim a tax deduction on your other income (e.g. if you made a net loss of $10,000 on the property and earn $80,000 per year, you may only need to pay tax on $70,000)|
|The property is generating rental income and capital gains||The property is solely generating capital gains|
The right investment strategy will depend on your individual circumstances and what financial goals you want to achieve. For example, some investors choose to have a portfolio with both negative and positive geared properties.
Your investment strategies should be aligned to your personal circumstances and risk preferences, and you should consider consulting with a financial adviser before purchasing an investment property.
Be sure to have a good understanding of the effects of gearing before you speak to a lender.
You can check out our investment property loan products and see which one will be perfect for you so you can start investing today.