Negative, Positive & Neutral Gearing… wtf?!
You’re looking at buying an investment property and suddenly everyone starts talking about ‘gearing’... negative... positive... neutral... wtf?!
What does it all mean? It’s actually very important you understand the basics of it, if you are investing in property. So let’s investigate.
When it comes to investing, the term 'gearing' refers to borrowing to buy an asset. It is simply a way to describe borrowing to invest. So if you take out a loan to buy a rental property, your investment is said to be geared.
Most investors use some gearing in the form of their mortgage, to fund their rental property.
What is negative gearing?
Negative gearing occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.
What is neutral gearing?
Neutral gearing is when you borrow money to invest into an asset and the income you make from that investment, i.e. the rent, is equal to your expenses. This means that you are breaking even on your investment and cannot deduct any losses from your taxable income.
What is positive gearing?
Positive gearing is when you borrow money to invest into an asset and the income you make from that investment, i.e. the rent, is more than your expenses.
This means that you are earning a consistent income from your investment property, and will also make a capital gain from the sale of the property if house values increase during your ownership.
A lot of people miscalculate and think their property is positively geared because they are getting more rental income that the cost of their mortgage.. But don’t forget to include all the expenses on your investment property - body corp fees, insurance costs, property management fees, water bills, rates bills etc.
A few things to think about:
Positive gearing means you have passive income coming from your investment property.
Positive gearing means you won’t be able to make any deductions from your taxable income and the income from your investment property will be subject to income tax at your marginal tax rate.
Negative gearing means you need a reliable cash flow to cover pre-tax borrowing costs and to earn enough income to meet their loan repayments.
Before deciding on which gearing strategy works best for you, we’d recommend speaking to a financial advisor, so that you better understand the potential pitfalls and rewards.
Thanks for reading.
Tabitha