This article is part two in a two part series on understanding negative gearing. If you haven’t already, read part one first, ‘WTF is negative gearing and positive gearing?’

‍

So now you know what negative gearing is and you can actually nod knowingly when that coworker brings up their investment property dilemmas at lunch again.

So let’s go a step further and look at the pros and cons of negatively gearing your investment property.

Quick reminder in case you forgot, negative gearing is where the rental income from your investment property is lower than the costs of maintaining the property (interest on your mortgage, council and water rates, repair costs etc).

It’s a strategy that involves making losses on your property in the short-term, which will ideally be outweighed by long term capital gain.

In fact, according to the ATO, there are 1.26 million taxpayers who negatively gear their property with an average loss of $8,930 per year.

First up, let’s talk about the pros.

1. You get to claim the losses

The juiciest advantage of negative gearing is that the losses made on your investment property can be claimed as tax deductions… and effectively reduce your taxable income.

For example, Andy earned $25,000 over the 2022-23 financial year in rental income, and he’s coughed up $35,000 of cost associated with holding the property in the same time, leading to a loss of $10,000.

Andy’s only other source of income is his salary as a physiotherapist where he earns $75,000, bringing his total taxable income to $75,000 + $25,000 = $100,000.

Without negative gearing:

• Andy’s marginal tax rate is 34.5 cents for the year including the 2% Medicare Levy so his tax payable comes to $22,967.

With negative gearing:

• Since Andy’s got $10,000 worth of property expenses that he can claim as a tax deduction, his taxable income will now be $90,000 (ie $100,000 - $10,000).
• Andy’s marginal tax rate is still 34.5 cents for the year. His tax payable will be $19,717
• Therefore, he’s saved $3,250 in tax as a result of negative gearing.

Wahoo! Less tax to pay.

2. Long term capital gains.

The idea is that in the long term, the increase in the value of the property will outweigh the rental losses you’ve copped till now, and you can eventually cash out on a win.

For example, if Andy held onto a $500,000 property for 10 years and his annual losses from maintaining the property were $6,750 ($10,000 - $3,250), that would amount to $67,500 over 10 years.

But the average house price has increased by 73.92%. So if Andy sold the house, it could be worth $869,000.

That’s a pretty tasty pay off.

But like any investment strategy, there are downsides when it comes to negative gearing too that are important to be aware of. 

1. Cash flow be tight

Since rental income isn’t enough to cover all expenses, an investor needs to have excess cash on hand to fund the difference, especially in the earlier years of owning the property.

This can be extra tough in times like now when interest rates are higher, and investors are shelling out more cash to maintain their property.

Suddenly you could find yourself saying goodbye to those iced-matcha lattes and concert tickets because property maintenance costs are just too high.

 So before you negatively gear, you want to be confident that you’re in a financial position to service your property, and prepared for any lifestyle sacrifices you may need to make.

2. Not the best for housing affordability

As great as negative gearing is, not everyone is a fan…and that’s because negative gearing has the potential to worsen housing affordability.

The allure of those tax benefits can drive up demand for investment properties, which increases competition in the market and pushes up prices.

And that means it’s more challenging for first-home buyers and lower-income individuals to enter the market.

‍When is it beneficial to use negative gearing?

Deciding if negative gearing is the right investment strategy for you ultimately depends on your investment goals and how you want your investment journey to look.

If you’re looking to earn passive income in the short-medium term, you might be better off opting for a positively geared property.

But if you’re looking to capitalise on long term capital gains, and you have the cashflow to keep up with some extra costs, then negative gearing might be your bet.

Regardless, it’s a good idea to seek some professional advice where appropriate before making any big investment decisions.

What do you think?

Is negative gearing just a tax-effective way to invest in property? Or is it keeping you out of the housing market?

We want to hear your thoughts in the comments section!