Whether you’re an established property investor or contemplating purchasing your first investment property, you may care to familiarise yourself with the way that negative gearing works.
A property is considered to be negatively geared if the owner has taken on debt in order to acquire it and the net rental income is less than the costs of maintaining the property (including the interest paid on the loan). Investors with negatively geared properties are able to claim the shortfall between their associated costs and rental income as a deduction against their total taxable income. In the event that your taxable income is insufficient to absorb the difference, then the remaining deduction can be carried forward to the next financial year.
Many Australians would not be able to enter the real estate market without taking on some form of debt. While taking on debt allows you to make investments that would otherwise have been beyond your reach, it also ramps up your risk profile because you will have a greater amount invested. Furthermore, if your investment property is underperforming, you remain responsible for making loan repayments.
Obviously, it is preferable to have an investment property that is positively geared, meaning that rental income covers loan repayments, interest and routine maintenance. Paying tax on a profit is typically considered to be a better option than minimising your tax liability while making a loss.
Even if you think that your investment property will be positively geared, understanding the benefits of negative gearing can give you a little peace of mind. You know that if the property does lose money, you will be able to offset the loss against your taxable income. When a property is positively geared, the income earned is added to your total taxable income. As such, it is taxed at your marginal tax rate. The same applies to any capital gain that you make from selling a property.