How does negative gearing work?

Over the past two videos, we have examined the reasons behind the recent surge in house prices and delved into the concept of interest rates. Now, let’s turn our attention to negative gearing, a term commonly associated with investment properties, older Australians, elections, and taxes. Let’s break it down.

Firstly, gearing refers to borrowing money from a bank to purchase an investment property, thereby “gearing” the property. Negative gearing, on the other hand, refers to a situation where the cost of owning an investment property, including mortgage repayments, exceeds the rental income generated. For instance, if the weekly mortgage repayment for an investment property amounts to $1,000, but the rent received from tenants is only $800, the property is considered negatively geared.

Conversely, if the weekly mortgage repayment is $1,000 and the rental income is $1,200, the property is positively geared. However, why would someone opt for negative gearing when it results in a financial loss? The answer lies in tax deductions. The mentioned $200 weekly loss serves as an investment strategy.

This loss indicates to the Australian Taxation Office that the property owner’s taxable income is lower than their salary due to the loss incurred from the property investment. For instance, if the property owner earns $130,000 per year from their job but experiences a $30,000 loss from the rental property, this loss is deducted from their salary. As a result, the owner’s taxable income for that year is reduced to $100,000.

Is negatively gearing your investment property worth it?

By utilising these deductions, the property owner pays less tax. In summary, those who actively engage in negative gearing expect to benefit from tax advantages. However, it’s not solely about tax deductions. Investing in property is also a popular means of wealth accumulation. Over the long term, property owners hope that the value of their house will appreciate significantly.

Nevertheless, this outcome doesn’t always occur, thereby introducing a risk factor. When the property is eventually sold, ideally at a higher price than the purchase price, the owner will make a profit subject to capital gains tax. This constitutes the investment aspect. Ultimately, the increase in property value outweighs the accumulated losses. So, why does negative gearing impact the housing market?

The answer is quite straightforward. It means that more investors are vying for the same properties because of the enticing tax benefits. As a first-time homebuyer attending an auction for a two-bedroom apartment, you might find yourself competing against investors seeking negative gearing opportunities. In previous elections, the Labor Party proposed a policy whereby negative gearing would only be applicable to new properties, aiming to make the housing market more accessible for young people. However, many experts believe that this policy contributed to Labor’s electoral defeat in 2019, as it was a challenging proposition to sell to older Australians.

Up next, we will discuss potential solutions on how to fix the property crisis and seek the insights of an expert.