Negative Gearing vs Positive Gearing
Negative gearing is one of the most misunderstood concepts in income tax and is something commonly said in the media without any real explanation.
Simply, gearing is “borrowing to invest”. It allows you to invest more than what you currently have, which then means you gain more profit if it’s successful. Conversely, it will mean your losses are greater too.
Negative gearing is the concept of using interest costs as a deduction against the annual taxable profit of the asset. Using an investment rental property as an example (as this is the most common asset that is geared);
After taking into account tenant income, adding the costs of the property (rates, water, repairs, advertising, real estate commission) to the interest paid for the year, an investor will almost always come out to a negative figure. This means during the year you have had to pay actual cash out of your bank to keep the rental property afloat. This cost out of your pocket can be used as a tax deduction against your salary & wages income, which then saves you income tax.
Why Would You Want An Investment That Makes A Negative Gearing Loss?
While making a loss on an investment might seem counterproductive, some people are willing to do this as they believe that the capital gain when they sell the asset will more than offset those accumulated losses.
Especially in the economic situation at present, investors might also find themselves unexpectedly in a loss position.
There are capital gains income tax concessions where the asset has been owned for more than 12 months allowing investors to get the full tax deduction on the losses but only pay tax on half the profits.
It is not only investment properties that can be negatively geared. You can borrow money for any investment – shares are often used as the franking credits and dividend yield can make them more attractive than property to those who can beat the stock market or if property isn’t in a bull market.
In the current income tax system, a negatively geared investment has the potential to give you a cash tax refund of anywhere between 19%-47% of the loss. This can really cushion the blow and help you to pay off the loan faster.
What Is Positive Gearing?
On the other side of negative gearing is positive gearing. Using an investment rental property as an example again; it is when your rental property expenses (including interest) are less than your tenant income.
In this situation you can use the rent to pay ALL of the expenses and then have money left over but while this does seem like a dream investment scenario, it can be very difficult to achieve.
To positively gear an investment, you will need to either have borrowed less in the first place, or have repaid a large amount of the debt.
We are very experienced in rental property deductions, from depreciation to interest to repairs. Investors need to be very careful now regarding travel due to the recent changes and we can help guide you through this.
If you are looking for deduction guidance or thinking it’s time you made a change of accountant, please give us a call on (03) 8568 3606. With over ten years of combined experience working with a diverse range of clients, Bookkept is well equipped to assist your business. We offer both personal & business tax services, and would love to help you succeed.