The Difference Between Negative and Positive Gearing

The Difference Between Negative and Positive Gearing

27 November 2023

You’ve no doubt heard the buzzwords Negative & Positive Gearing but have you ever given any real thought to what they actually mean?

 

The Meaning of Gearing

In simple terms, gearing refers to borrowing money for the purchase of an asset, in this case property. Whether a property is negatively or positively geared depends on whether or not it generates a profit or loss. For example, if you purchase an investment property and the rent you receive (income) is less than the total costs of ownership (outgoings), then the property is negatively geared, as it is generating a financial loss. If the rental income exceeds the total cost of owning the property, then the property is generating a profit, and therefore is positively geared.

If a property is neutral geared, this means it neither incurs a loss or turns a profit – The income and costs are equal.

Negative gearing

If your investment property is generating a loss, then this is what is known as negative gearing. You could be forgiven for wondering why anybody would want to purchase an asset that loses money, but in certain circumstances, this strategy has tangible benefits for investors. Most importantly, any loss that your property makes can be used as a tax deduction, so for high income earners, who are looking for a means to minimize their tax burden, this can be an excellent financial strategy. But negative gearing can be risky for those on modest incomes, where any increase in costs (or reduction in income) could have a significant impact on your monthly budget and cause massive cash flow problems.

Investors who invest in negatively geared property tend to rely mostly on capital growth in order to make money.

Positive gearing

This is essentially the opposite of negative gearing – In this instance, the property generates enough income to cover the costs involved with owning and maintaining the property, and turn a profit as well. This strategy is obviously attractive, and presents significantly lower short-term risk than negative gearing. One thing you should remember however, is that while negative gearing can be a useful mechanism to minimise tax, by virtue of the fact that it generates a profit, a positively geared property will also incur tax payable.

Things to Consider

Beyond the questions around tax, there is also the issue of capital growth to consider. The term capital growth refers to the increase in the value of the property over a period of time, and some properties tend to increase in value more than others due to factors such as size, location, flexibility of potential use and overall lifestyle desirability. Properties which tend to produce higher than average income, sufficient to cover the cost of ownership plus turn a profit, also have a tendency to be high risk investments that often don’t experience the same degree of capital appreciation as other, more secure investments. Investment properties with high capital growth prospects, such as established houses in inner city locations, are often negatively geared, but also tend to appreciate substantially in value over time. On the flipside of the coin, positively geared investment properties which tend to produce high levels of income such as student or rooming accommodation and dual occupancy homes, turn regular profits but often don’t tend to yield high capital growth.

‘Til next time, ciao 😊

 

Disclaimer: The information is this article is for general information only, it is not intended and should not be considered as either legal or financial advice. The information contained herein should not be relied upon solely and all parties are encouraged to obtain their own independent advice before making any financial decision.

 

 

Lee Knutsen

Article by Lee Knutsen

Co-founder & Managing Director of House, Lee Knutsen first entered the real estate industry in 2006 as a residential sales specialist. After more than a decade as a sales agent…

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