Understanding the Difference: Negative Gearing vs Positive

Introduction

When it comes to property investment, understanding the concepts of negative gearing and positive gearing is crucial. These terms refer to whether the income generated from your investment property is lower or higher than the expenses associated with owning it. The decision between negative gearing and positive gearing can have significant implications for your financial situation, tax obligations, and overall investment strategy. In this comprehensive guide, we will delve into the differences between negative and positive gearing, explore their benefits and disadvantages, discuss the costs involved, and provide insights into calculating whether a property is negatively or positively geared. We will also highlight the importance of seeking expert advice and present a balanced view of both strategies.

What is Negative Gearing?

Negative gearing occurs when the costs of owning a property exceed the income it generates. In other words, you are running the property at a loss. While this may initially seem risky, negative gearing offers potential benefits for investors. Despite the overall loss, the value of your property may appreciate over time, offsetting the financial shortfall. Additionally, negative gearing allows you to deduct certain expenses from your taxable income, potentially reducing your tax liability. However, it is vital to consider tax implications, such as capital gains tax, when selling the property. It is important to note that negative gearing requires sufficient cash flow to cover the losses until tax time, which can tie up your available funds and make building your investment portfolio more challenging.

The Benefits of Negative Gearing

While negative gearing may result in short-term losses, it offers several potential benefits for property investors. Let’s explore these benefits in more detail:

Capital Appreciation: Despite the ongoing loss, negatively geared properties have the potential to experience significant capital appreciation over time. The increase in the property’s value can offset the initial losses and provide substantial long-term gains.
Tax Deductions: One of the key advantages of negative gearing is the ability to deduct certain expenses from your taxable income. This includes costs such as interest payments, maintenance fees, insurance premiums, and council rates. By reducing your taxable income, negative gearing can potentially lower your overall tax liability.
Long-Term Investment Strategy: Negative gearing can be an effective long-term investment strategy, particularly for investors focused on capital growth rather than immediate cash flow. By sacrificing short-term profits, investors can benefit from significant wealth accumulation over time.

It is important to note that the benefits of negative gearing should not be the sole driving factor in choosing an investment strategy. While tax savings and potential capital appreciation are appealing, it is essential to consider your overall financial goals and assess the risks associated with negative gearing.

The Disadvantages of Negative Gearing

Negative gearing also comes with its share of disadvantages. It is important to weigh these drawbacks against the potential benefits before deciding to pursue a negatively geared investment property. Here are some key disadvantages to consider:

Cash Flow Challenges: Negative gearing requires investors to have sufficient cash flow to cover the ongoing losses until tax deductions can be claimed. This can put a strain on your finances and limit your ability to invest in other properties or ventures.
Vulnerability to Interest Rate Increases: Investors who heavily rely on negative gearing may be vulnerable to interest rate rises. An increase in mortgage interest rates can further exacerbate the losses associated with a negatively geared property, potentially putting financial strain on the investor.
Impact on Portfolio Growth: The ongoing losses from negatively geared properties can tie up your available funds, making it more challenging to expand and diversify your investment portfolio. This limitation can hinder your ability to take advantage of other investment opportunities.

It is crucial to carefully consider your financial position, risk tolerance, and long-term investment goals before embarking on a negative gearing strategy. While the potential benefits are enticing, it is essential to have a sound financial plan and contingency measures in place to mitigate the risks.

Costs of Negative Gearing

Before opting for negative gearing, it is essential to assess whether you can afford the ongoing out-of-pocket expenses associated with the strategy. The costs of negative gearing can include:

Mortgage Repayments: The principal and interest repayments on your investment property’s mortgage can be a significant expense. It is important to factor in these costs when calculating the overall financial viability of a negatively geared property.
Property Maintenance and Repairs: Owning a property requires regular maintenance and occasional repairs. These costs can add up over time and should be included in your calculations to ensure you can cover the expenses associated with property upkeep.
Council Rates and Taxes: Property owners are responsible for paying council rates and taxes, which can vary depending on the location and value of the property. These costs should be considered when determining the financial feasibility of a negatively geared investment.
Insurance Premiums: Insuring your investment property is essential to protect against potential damages and liabilities. The cost of insurance premiums should be factored into your overall expenses.
Other Associated Expenses: Additional expenses, such as property management fees, advertising costs, and legal fees, should also be taken into account when assessing the financial viability of a negatively geared property.

It is crucial to carefully analyze the ongoing costs and ensure that you have the financial capacity to cover them without jeopardizing your overall financial stability.

What is Positive Gearing?

In contrast to negative gearing, positive gearing occurs when the income generated from your investment property exceeds the expenses associated with owning it. In simpler terms, you are making a profit from your property investment. Positive gearing is often referred to as “positive cash flow” because it provides immediate financial returns. Let’s take a closer look at the benefits and considerations of positive gearing.

The Benefits of Positive Gearing

Positive gearing offers several benefits that may appeal to property investors. Here are some advantages of positive gearing:

Immediate Profitability: With positive gearing, your investment property generates income that exceeds the expenses, resulting in immediate profitability. This additional income can be used to reinvest in other properties, pay down your mortgage faster, or enhance your overall financial position.
Loan Repayment Acceleration: The surplus income generated from positive gearing can be directed towards paying down your mortgage principal. This can help you build equity faster and potentially shorten the loan term.
Portfolio Expansion: The positive cash flow from a positively geared property can provide you with additional funds to invest in more properties, thereby expanding your investment portfolio and increasing your potential returns.

Positive gearing can be an attractive option for investors seeking regular income and quicker returns from their property investments. However, it is essential to consider the potential drawbacks before solely focusing on positive gearing as a strategy.

The Disadvantages of Positive Gearing

While positive gearing offers immediate profitability, it also comes with certain disadvantages. Here are some key considerations:

Higher Tax Obligations: With positive gearing, the additional income generated from your investment property is subject to taxation. This can potentially increase your overall tax liability, reducing the net return on your investment.
Limited Capital Appreciation: Positive gearing is primarily focused on generating regular income rather than long-term capital growth. This means that the property’s value may not appreciate as significantly compared to negatively geared properties, potentially limiting your overall returns.
Market Fluctuations: Positive gearing relies heavily on consistent rental income. If rental demand declines or market conditions change, you may face challenges in maintaining positive cash flow.

It is crucial to assess your financial goals, risk tolerance, and investment strategy when considering positive gearing. While the immediate profitability may be appealing, it is important to evaluate the potential long-term implications and diversify your investment portfolio accordingly.

How to Calculate Negative or Positive Gearing

Determining whether a property is negatively or positively geared requires careful calculation of income and expenses. Here are the steps to calculate the gearing of a property:

Calculate Rental Income: Determine the total rental income you receive from the property over a specific period. This includes regular rent payments, any additional income from sources such as parking fees or storage rent, and any government rental assistance.
Assess Expenses: Compile a comprehensive list of all expenses associated with the property. This includes mortgage repayments, council rates, insurance premiums, property management fees, maintenance and repair costs, and any other relevant expenses.
Subtract Expenses from Income: Subtract the total expenses from the rental income to determine the net cash flow. If the net cash flow is positive, the property is positively geared. If the net cash flow is negative, the property is negatively geared.

It is important to consider potential tax deductions and consult with a financial advisor or accountant to ensure accurate calculations based on your specific circumstances. They can provide guidance on deducting expenses and help you understand the tax implications of your investment strategy.

Seeking Expert Advice

When it comes to property investment, seeking expert advice is always a wise decision. An accountant or financial advisor can provide personalised guidance based on your unique circumstances, goals, and risk tolerance. They can help you determine the most suitable investment strategy, assess the financial viability of potential properties, and navigate the complexities of negative and positive gearing.

Expert advice can also assist you in understanding the tax implications of your investment decisions and ensure compliance with relevant regulations. By working with professionals, you can make informed choices that align with your financial objectives and maximise the benefits of your property investments.

At Property First Investments, we facilitate the entire process from start to finish for our clients to ensure that their property investment journey is. guaranteed success. We help you purchase the right home at the right place, in locations set for growth. we organise all the professionals you will need from the accountants, brokers, conveyancer, lawyers, builders, property managers etc until you have the keys in hand to your new property.

Click here to get started with personalised guidance.

Conclusion

Understanding the difference between negative gearing and positive gearing is crucial for property investors. While negative gearing allows investors to offset losses through potential capital appreciation and tax deductions, it requires careful financial planning and sufficient cash flow to cover ongoing expenses. On the other hand, positive gearing offers immediate profitability but may result in higher tax obligations and limited capital growth.

When deciding between negative and positive gearing, it is important to consider your financial goals, risk tolerance, and long-term investment strategy. Thoroughly analyse the costs, benefits, and potential risks associated with each approach. Seek professional advice to ensure you make well-informed decisions that align with your individual circumstances.

Property investment can be a rewarding venture, but it is essential to conduct thorough research, assess the market conditions, and consider all relevant factors before committing to a particular investment strategy. By doing so, you can increase your chances of achieving your financial goals and building a successful property portfolio.