Negative Gearing Explained

Negative Gearing Explained

Negative gearing is a term you may have heard thrown around, but do you really know what it means? It’s an investment strategy that has become increasingly popular in recent years as a way to use your income to generate growth on assets. While negative gearing does come with some risks and restrictions, understanding how it works could potentially help you turn your finances around for the better and create more financial freedom. In this post we will break down exactly what negative gearing is, how it works and why Millennials and Gen Xers are taking advantage of its benefits. Get ready to unlock the power behind Negative Gearing!

1.     What is negative gearing and how does it work?

Negative gearing is simply when the cost (including interest) of an investment exceeds the income. The difference is tax deductible and will be taken off your taxable income. Here is a simple example of how is works.

Investment worth $500,000 earning $300 p/w after costs.

Loan of 400,000 with $400 p/w in interest.

$400 – $300 = $100 loss p/w.

$100 p/w annualised = $5200 tax deduction off your taxable income.

2.     Pros and cons of using negative gearing as an investment strategy

Pros:

• Can help with ongoing running cost pressures of investments in high interest rate environments.
• Creates tax relief for growth investors by offsetting the loss.

Cons:

• The strategy is reliant on capital gains or massive debt reduction.
• There is no guarantee that the investment will grow in value.
• You are making a loss on the investment on an ongoing basis.
• Can inflate asset prices.

Make sure to check out our other “ most under utilised tax saving” article if you are interesting in how you can reduce your tax.

3.     Tax implications of negative gearing

Let’s assume that you are earning $140,000 in the above scenario. That means you are in the $120,000-$180,000 tax bracket (the second highest) which means you pay 37 cents for every $1 you earn in that bracket.

By having the above loss, you can reduce your income by $5,200 which saves you $3,172 in tax.

This brings the total after tax loss down to $2,028 for the year.

4.     Potential risks of relying on negative gearing for your investments

By relying on negative gearing you run the risk of:

• Your asset never growing.
• Not being able to continue wearing the loss.
• Losing your income and the tax advantages.

5.     Tips for making the most out of your strategy

• Have a high income. Low incomes struggle to get a benefit from a negative gearing strategy.
• Obtain support when purchasing an investment to give yourself the best shot of investment growth.
• Have plenty of disposable income. You don’t want to be left in the lurch if costs blow out and you can’t afford it.
• Never invest just for tax reasons. Negative gearing is a potential benefit to an investment. Not the reason why you should invest.

How do you know if it’s is right for you?

If you have a high disposable income and you are in a higher tax bracket then negative gearing might be appropriate for you to consider as a part of a high growth investment strategy. Consult your financial adviser or accountant to see if you fit the minimum requirements to make it a potential success.

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You can also find some more information on the ATO website HERE or ASIC moneysmart website HERE.