Both positive and negative gearing can be beneficial for investors. This article outlines the pros and cons.
As a real estate investor, one of the biggest decisions you may have to make beyond which property to buy, is whether to positively or negatively gear your investment property.
In a nutshell, positive gearing gives you income; negative gearing doesn’t. However, negative gearing currently comes with real tax advantages.
What Is Positive Gearing?
Positive gearing is when you borrow money to invest and the income you earn from your investment is more than the interest you’re paying on the loan plus your other property-related expenses. So the net effect is positive and the rent provides an income stream.
The obvious benefit of positive gearing is that revenue stream - extra money for you to take away and do what you like with.
If you have a mortgage on the property, having your property positively geared should also give you a bit of breathing room to cover extra repayments should interest rates go up.
The main drawback of positive gearing is that any income you make from the property will be taxed at your marginal tax rate. This could mean you’d be taxed as much as 47 per cent on what the property brings in.
What To Consider
Unless you already have a substantial deposit, positive gearing won’t always be an option in Sydney’s Eastern suburbs - at least when you first buy an investment property. Because this is a blue chip area, yields tend to be lower than in some areas on the city fringe or in regional Australia. That means the income you receive may not always cover your outgoings.
The trade off though is that the Eastern Suburbs is an established and quality property market with a history of strong and stable capital growth. That means property here has traditionally been a reliable and solid long-term investment.
What Is Negative Gearing?
Negative gearing happens when the income you’re getting from an investment property is less than your expenses. This means you need to top it up with money from another source.
Negative gearing is a popular way to buy an investment property due to the generous tax breaks it affords investors. Currently, the Australian government lets you offset the loss you make on interest repayments against your income tax. You can also deduct depreciation, capital works spending and management and maintenance costs. Effectively these expenses come out of your pre-tax income, which can be a significant saving.
Because of this, negative gearing is a little more common than positive gearing. According to the ATO, of the 2,047,000 Australians who own an investment property, more than half, or 1,277,000, negatively gear their investment property, and the average annual deduction is $8,702.
Plus, assuming the value of your investment property goes up over time, as blue chip real estate typically does in places like Sydney’s Eastern Suburbs, a negatively geared property can earn you good capital gains. Also, as time goes by rents usually rise and you pay down your mortgage.
So a negatively geared property should eventually end up positively geared over time, and generating an solid income for you.
The downside of negative gearing is that you’re still essentially making a loss and so will need to use another source of income to cover your costs in the short term. Should interest rates go up this can lead to financial stress.
What To Consider
Negative gearing leaves investors more vulnerable to market downturns if rental yields fall and your shortfall grows. And while investors typically use negative gearing for long-term capital growth, this is never guaranteed.
The Future Of Negative Gearing
While negative gearing appeals to a lot of Eastern Suburbs investors at the moment because of the tax breaks, there’s no guarantee that negative gearing will continue in its current form, especially if there is a change of government federally.
To learn more about positive and negative gearing and to discuss your investment options, contact our team of specialists today.