Recently, negative gearing has been making waves in the news and with rental affordability becoming a serious issue in Australia, various political parties have weighed in on the issue.

While some argue that it’s a vital tool for encouraging investment in housing and fixing the housing crisis, others believe it fuels property price increases, contributing to housing affordability issues and making home ownership increasingly difficult for first-time buyers.

However, there are concerns that any reforms to this widely used tax concession might reduce the supply of homes for renters by making housing investment less attractive.

And while there are certainly arguments for and against tinkering with this tax law, a further consideration contributing to debate, is the increase in gearing claims over the last few years.

Some $8.7 billion in negative gearing claims were made in the 2020/21 financial year, according to the latest Treasury analysis, and this is anticipated to soar due to the change from record low interest rates to a climate of higher rates in record time.i

Despite increases in rents, rental payments are still lagging behind loan repayments on properties that may have been bought at recent high prices, so the number of investment property owners who are negatively geared has increased. ii

To understand what all this means, it’s helpful to look at what negative gearing is and how it works.

What is negative gearing?

Negative gearing is an investment and tax minimisation strategy, primarily associated with property, where the costs of owning an investment property exceed the income it generates. This might sound like a strange way to invest, but it can be quite beneficial when you know how to play the game.

In simple terms, if you’re losing money on your property each year, that loss can be used to reduce your taxable income. For example, if you’re paying more in mortgage repayments, maintenance, and other expenses than you’re earning in rent, you can declare that loss on your tax return. By claiming the losses of your rental income as a tax deduction, you can reduce your overall taxable income, and hence pay less tax, which is appealing for many investors.

Negative gearing is common among Australian investors. In most years, the majority of investors spend more on their investment properties than they earn in rent.

While the proportion of investors who are negatively geared changes a bit, largely driven by interest rate movements, generally (except for 2020-22 when interest rates were at record lows), more than half of investors have been negatively geared for at least three decades. ⁱⁱⁱ

Negative gearing case study

Let’s break it down with a quick example.

Michael owns an investment property - a two bedroom apartment which he bought for $600,000.

He rents it out for round $800 per week.

His property expenses, consisting of principal and interest payments on the mortgage, property maintenance and repairs, real estate agent fees, insurance, and council and water rates, total around $1,000 a week.

That means he’s losing (or is out of pocket) about $200 a week, which affects his lifestyle as he will need to contribute an additional $200 per week to cover the cost of owning the property. But this isn’t as bad as it seems. That adds up to around a $10,400 loss from his investment property annually.

By declaring that $10,400 loss on his tax return, he can reduce his taxable income. Say Michael’s regular job pays him $80,000 a year, he can effectively lower this figure by the $10,400 loss he has incurred, which means he’ll pay less tax overall.

The potential upside

So, why would anyone want to invest in a property that’s losing money, even if it means you get a bit of a tax break? The key here is capital growth. While you may be negatively geared in the short term, many investors bank on the property appreciating over time.

Let’s say over time that property that was bought for $600,000 rises in value to $800,000. When you eventually sell it, you could make a tidy profit, far exceeding the losses you incurred along the way. Historically, property in Australia has appreciated in value over the long term, making it a popular investment choice.

Keep in mind, there may be tax implications (like capital gains tax) that you’ll need to factor in if, or when you sell.

Risks and challenges

While there are some certain benefits associated with negative gearing, investing in property isn’t without its challenges.

Property investment requires a substantial initial outlay, not to mention the ongoing costs such as maintenance, rates, and insurance. Investors considering this type of arrangement need to have the financial stability to fund the shortfall out of pocket until the property becomes positively geared (meaning your investment property rental return is higher than your repayments and other costs) or is sold.

Plus, the property market can be unpredictable. Prices can fluctuate based on a multitude of factors, including economic conditions, interest rates, and even local demand.

It’s worth noting that some proposed changes could affect the way negative gearing works, so staying informed is crucial for existing or potential property investors.

If investing in property is something you are interested in exploring, we are here to help you qualify for an investment loan that’s competitive.

i Suburbs set to lose most from negative gearing change | Property Investment Professionals of Australia

ii These Australians are most likely to negatively gear their properties | Australian Financial Review

iii A Brief history of Property Gearing in Australia | capitl.

Coleman Wealth is an authorised representative of GPS Wealth Limited ABN 17 005 482 726 holder of Australian financial services licence number 254544 (“Count”). Count is owned by Count Limited ABN 111 26 990 832 of GPO Box 1453, Sydney NSW 2001. Count Limited is listed on the Australian Stock Exchange.

The information on this web page is not financial product advice and is provided for information only.