Positive and Negative Gearing
‘Gearing’ is a term commonly thrown around when purchasing investment properties. We are going to discuss what makes an investment property positive or negatively geared and what you should consider when considering the most beneficial strategy for you.
Positive gearing is when the amount of rental income received is higher than the property-related expenses. These costs include home loan repayments, property maintenance, and real estate rental costs. In this case, you are making a profit from your investment property.
Positively geared properties are common in areas of strong demand for rental properties and times of low interest rates.
As an example, Jane had a $50,000 deposit and borrowed $400,000 to buy a $450,000 investment property. Her monthly repayments were $1,800 and she also spent $1,500 in other property-related expenses. Her total annual outgoings were $23,100. She rented this property at $500 per week, or $26,000 per annum, which meant she gained $2,900 per year.
The main benefit of a positively geared property is that the rental income earned will put more money into your pocket and allow you to repay your property more confidently. You will also have an asset that will continue to increase in value over time.
The main drawback is that the income you earn is taxable and may push you into a higher tax bracket.
The more common term these days is negative gearing and this is mainly due to the median price of properties versus the income received. When your rental income is less than your monthly outgoings, your property is negatively geared.
In the same example as above, this time, Jane could only rent out her property at $400 per week, or $21,840 per annum. Plus, other expenses, such as rates, levies, and maintenance, added up to $1,500. With annual repayments and expenses totaling $23,100, Jane had to include an additional $1,260 of her own money to cover the property expenses. This means Jane will be able to claim $1,260 as tax deductions, reducing what she may have to pay in tax.
The main benefit of a negatively geared property is that any rental loss you incur may be offset against other income you earn. Your taxable income is effectively reduced as is the amount of tax you have to pay. Negative gearing tends to benefit high-income earners more as the higher income is offset by the tax deductions.
The main drawback is that running at a loss does have risks, such as not being able to afford to pay for the property if your income suddenly falls or interest rates increase.
There are a number of rental expenses you can claim as tax deductions, such as the interest portion of your home loan repayments as well as depreciable items. Other expenses include things like council rates, repairs and maintenance costs.
Positive vs. Negative gearing – which should you choose?
It comes down to your personal circumstances, preferences and risk tolerance. We recommend you talk to a financial advisor, mortgage broker or accountant to work out your investment decisions.
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