TL;DR: Negative gearing describes a situation when expenses associated with an asset are greater than the income earned from that asset.
Why would someone do negative gearing if they are making a loss?
Two words: tax deduction
But how does the tax deduction work?
As we said, negative gearing occurs when the costs of owning a property exceed the rent returns earned. That ‘loss’ is an investment strategy. The loss indicates to the Australian Taxation Office that the owner’s taxable income is lower than their salary after deductions, as they are making a ‘loss’ on their property investment. For example, if the owner through their job makes $130,000 per year, but is losing $30,000 per year from owning the rental property, that loss is subtracted from the owner’s salary. The owner’s taxable income that year is then brought down to $100,000. With those deductions, the owner will pay less in tax.
In summary: Someone who is actively negatively gearing expects to gain from tax benefits.
So it’s just for a tax deduction?
Yes and no, a tax deduction is only part of it. It’s also a long term strategy.
When the owner eventually sells the house, it is hoped that the house will go up in value (this does not always happen though, so there is a risk) over a longer period of time. Through this, over time, the owner will ideally make a profit (minus capital gains tax) once the house is sold at a price that is higher than it was originally bought for. That is the investment aspect. Ideally, the gain in property value is more than all the losses.
Why are we talking about negative gearing?
Last week, Federal Labor announced it had dropped its negative gearing policy. At the 2019 election, Labor committed to limiting negative gearing to new properties only. A post-election review found this policy (among a suite of economic policies) were in part responsible for Labor’s shock loss.