Negative Gearing Explained

Negative gearing is a hot topic in Australia right now.

But what exactly is the policy, what are its advantages and disadvantages, and just why is it so controversial?

What is negative gearing?

Negative gearing occurs when the cost of owning an investment property – including interest on the home loan, maintenance and other expenses – exceeds the income it generates. Essentially, it means the property is making a cash loss.

Australian tax law lets you deduct this loss from your personal taxable income, potentially reducing how much tax you pay.

It might seem counterintuitive to invest in a property that operates at a cash loss. However, this property investment strategy banks on the property’s value increasing over time, alongside the benefits of reducing taxable income.

While this might sound appealing, there are both advantages and disadvantages to consider.

Pros of negative gearing

• Potential tax benefits: The most immediate advantage of negative gearing is the tax deduction on the loss made from the property. This can lead to tax savings, particularly for those in higher tax brackets.
• Capital growth potential: Investors often use negative gearing in the hope that the property’s value will increase over time. So while you might be making a cash loss in a particular year, you might be making a paper profit (if the capital growth exceeds the shortfall between your income and expenses).

Cons of negative gearing

• Risk to your cash flow: Since your property isn’t paying for itself, you need to have enough money elsewhere to cover these losses. This can strain your finances, especially if the losses are larger or last longer than expected.
• Market risks: If property values don’t go up as you expect, you could end up with a property that’s not worth as much as you hoped.
• Dependence on tax laws: Negative gearing’s attractiveness is closely tied to the current tax laws, which can change.

Is negative gearing right for you?

The suitability of negative gearing as a property investment strategy depends on several factors, including your financial situation, risk tolerance and investment goals.

Here are some considerations:

• Financial stability: Make sure you have the financial cushion to absorb the potential cash flow impacts of negative gearing, especially in unpredictable market conditions.
• Investment timeline: Negative gearing is generally considered a long-term strategy. Be prepared to hold onto your property for many years to realise the potential capital gains.
• Market research: Not all properties will appreciate in value as expected.So understanding the property market dynamics, including locations with potential for growth, is crucial.

The current debate

The debate around negative gearing has intensified after the Greens demanded changes to the tax concession as a condition for supporting the federal government’s Help to Buy scheme.

The Greens propose limiting negative gearing to a single investment property, arguing that the current system unfairly benefits investors over first home buyers and pushes up prices.

Similarly, the campaign group Everybody’s Home believes that negative gearing makes it hard for people to afford homes because it encourages investing in private property instead of social and affordable housing. They estimate the federal government has missed out on $38 billion since 2010 because of the tax break, arguing that this money could build over half a million social homes by 2033.

On the other side, the real estate and construction industries warn that limiting negative gearing could worsen the already low rental supply by disincentivising ‘mum and dad’ investors.

This position is supported by recent research from the Centre for Independent Studies, which found that tax concessions like negative gearing have a minimal effect on property prices compared to the significant impact of planning restrictions.

According to their report, planning rules have added over 40% to house prices in major cities, whereas tax concessions have only marginally increased values by between 1% and 4%.

Need a home loan? Whether you are a first home buyer, property investor or looking to refinance to a lower rate, Shore Financial can help. To discuss your options, call us on 1300 416 700, email us on info@shorefinancial.com.au or fill in this online form.