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What is the difference between positive versus negative gearing?

One of the advantages of investment property is that losses can be tax deductible. To do so however, means making a loss which can then be used to reduce your tax at tax time. This is called negative gearing.

On the other hand, if you make a profit on the investment, you’ll not be able to claim a tax deduction. You will, however, not make a loss on the way through. This is called positive gearing.

How positive and negative gearing works

In Australia, we have a very beneficial tax environment when it comes to property investment. This is especially true when you negatively gear. The following should help you consider the tax issues and advantages when buying an investment property.

Negative gearing

If you are in the highest tax bracket, you are paying a large proportion of tax on some of your income. Negative gearing will reduce your income to a lower tax bracket, by making a loss on the month by month cost - a loss you can claim in your tax return.

This approach assumes that the property that you have bought will increase in value over a period of time, and that this increase will outweigh the losses that you have made.

Each year you pay interest on your loan, which you are able to claim as an expense along with the other costs incurred during the year - such as property maintenance. You must also then declare the income received from the property. The difference will either be a profit or a loss. If it is a loss it will effectively reduce your taxable income. 

Positive gearing

Positive gearing is where the annual rental income received from the property is higher than the annual loan repayments and costs.

The benefit here is that you earn extra income but this is taxable. Also make sure you include the capital gains tax you will have to pay if you decide to sell the property.

Negative gearing and tax

Negative gearing simply means that your costs (interest repayments, fees and related repair and maintenance expenses) are more than the income you receive from the property. This might not sound like a smart idea but it is if you want to pay less tax on your personal income. The negative return (or loss) may help take you down to a lower tax bracket, reducing the overall tax rate and the amount of tax you pay.

But can you afford to make a loss every month (effectively) to produce lower income tax or a tax refund at the end of the financial year? If so, you can apply to have your ongoing tax calculated on your new lower income.

If you positive gear (i.e. the property income exceeds the costs) you won’t have the losses but you won’t have the tax advantages either.

A couple of things to remember: the interest and related expenses are a tax deduction. And don’t forget to factor in capital gains tax if you decide to sell.

When deciding whether to negatively gear or positively gear, talk to a financial planning expert, and stay informed on the property and rental markets.

Capital gains tax

The ‘capital gain’ is the profit you make on the capital value of a property, i.e when you sell.

The gain is your capital income (the sale price) minus your capital costs (the purchase price plus any previous expenses such as the price of the property and renovations). You should make sure you keep a good record of all expenses.

Capital gains tax is only payable on properties purchased after 20th September 1985. In general, no capital gains is payable on your place of residence. However, conditions apply if you own other properties. Capital gains can be a complex area, so it’s worth talking to a tax and investment professional.

You can find out more about capital gains tax and other tax issues, at the Australian Taxation Office.