A Beginner’s Guide to Positive and Negative Gearing

A Beginner’s Guide to Positive and Negative Gearing

Last updated on November 20th, 2020 at 10:51 am

If you’ve considered investing in the property market, there is a chance that you may have been baffled by the complexities of “positive” and “negative” gearing schemes.

However, determining whether your property will be positively geared or negatively geared is an important step in the investment process. For a better understanding of the benefits and potential drawbacks of these schemes, we have compared the two strategies below:

Positive Gearing

Opting for a positive gearing strategy is generally considered the safer and more conservative option. Positive gearing occurs when the rental income on your investment property exceeds the cost of maintaining it. This includes the cost of mortgage repayments, interest rates and maintenance fees. Positive gearing schemes are sometimes more favourable, as the extra cash-flow results in an immediate short-term profit.

Benefits

• Immediate short-term profit – Investors will immediately gain an additional stream of income.
• Low risk – If circumstances change and the investor loses their income, they will not be under pressure to pay the costs associated with multiple mortgages.

Drawbacks

• The additional funds are taxable – As with your regular income, any funds obtained on a positively geared property are subject to income tax.
• Less long-term gains – While you are immediately rewarded with additional income, it lacks the long-term payoff of a negatively geared property.
• It is circumstantial – Due to a range of circumstances, a positively geared property can quickly become negatively geared. For example, if you are forced to reduce the rental income, you may have to cover the extra costs personally.

Negative Gearing

Negative gearing occurs when the rental income is less than the costs of maintaining the home. As the property is running at a loss, investors need to use their own funds to make up the difference. The benefit of a negatively geared investment is that the value of the home is likely to grow in time. It is expected that the increased profit from selling the property will outweigh the initial financial losses. Further, thanks to the available tax deductions, negative gearing can be a helpful strategy for offsetting the costs of acquiring an investment property. Negatively geared homes are likely to be in more populated areas like capital cities, where there are fewer factors that can affect their value.

Benefits

• Greater long-term profit – Over time, the value of the property can be increased to the point where it exceeds the cost of maintaining it.
• Tax deductible – A negatively geared home allows you to claim tax deductions related to any expenses you incur, so you can reduce the shortfall in rent and ultimately reduce your taxable income.

Drawbacks

• Higher risk – If your circumstances change, or an investor loses their source of income, they are still required to cover the additional rent.
• Housing markets – Investors will need to be careful that the property does not lose value over time. They will also need to ensure that the property is sold at a time where the housing market is strong.
• You will need to budget – The ongoing costs associated with a long-term investment will add up. You may also need to consider you will be taxed on capital gains accrued when the property is sold.