Negative Gearing: Is There a Better Way?

Long used as a tax minimisation strategy, negative gearing has become almost a rite of passage for working Australians. However, we are seeing time and time again, instances of people using negative gearing without really understanding how it works and how it might not be the right strategy for their situation as it pertains to their home loan portfolio.

Using negative gearing as a primary means to save money on tax simply will not work in all cases, and should be approached with caution in combination with a comprehensive understanding of the associated risks.

What is negative gearing?
Negative gearing is when your income from an investment (such as dividends or rental income) is less than your interest and/or other expenses. If you negatively gear, your investment is initially making a loss which you hope you will make up with a capital gain when you sell your investment.

A loss can be used to reduce your taxable income, which will reduce the amount of tax you pay. Remember, you are only reducing your tax because the income from your investment isn’t covering your expenses. You will still need to cover the negative cash flow from other sources.

What are some of the cons of negative gearing?

Negative cash flow: A loss is a loss, even if it could be softened by tax deductions. Therefore, negatively geared properties are not suitable for investors whose aim is to create passive income. Without money to spare, investors may end up in a sticky situation of having to sell the property to avoid further debt.

Capital loss: Negative gearing relies almost 100 percent on the market increasing in value, and your property increasing in value, in order for you to make money. If it goes down in value, you can’t sell it. You can’t access equity, so you’re just paying money and getting absolutely nothing in return.

While holding a property for the long-term is likely to result to capital growth, no one is ever certain of how markets will move. In the event of unexpected market fluctuations, investors with negatively geared properties could be exposed to considerably higher risks as their success is more reliant on capital gains.

In contrast, a positive cash flow property provides guaranteed profit even when property prices remain stable or decline.

Limited serviceability: With limited cash flow, the investor may also be decreasing the limit of what they can afford or their borrowing capacity, thus making it harder to grow their portfolio moving forward.

So before you get caught up in the hype of negative gearing, it’s important to sit down and nut out your own investment strategy and what you hope to achieve from owning property.

Before making any major investment decision, investors are strongly encouraged to do their due diligence and engage professionals in order to get a better understanding of the strategies that will be fit for their wealth-creation journey based on their personal and financial goals, capabilities and limitations.

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All lending subject to status and lenders criteria. Terms & conditions apply. This document contains general information only. Your own personal circumstances have not been considered and you should seek independent financial advice prior to making any decision on a financial product.