The term “negative gearing” is classic jargon that can often be misunderstood. So what does “negative gearing” really mean?
An investment property is “negatively geared” when the mortgage interest and other tax deductions, such as management fees, rates and maintenance costs, are greater than the rental income. This results in a net loss that may be offset against your other income (such as your salary), which then lowers your overall tax bill.
In this way, the tax man as well as your tenant helps you pay for your investment property. While hopefully at the same time, your property is steadily appreciating in value. An example of how negative gearing works:
Mrs Smith, a property investor, buys a unit for $300k, puts in $50k of her own money and borrows the remaining $250K.
The annual interest calculated at 7% is $17,500* and the weekly rent is $300 or $15,600 a year.
Interest = $17,500
Rent = $15,600
Difference = -$ 1,900 (loss)
(*Example figure only, will vary with daily interest charges and frequency of mortgage payments)
Ongoing costs including rates, water, insurance, maintenance and depreciation allowances are $2,600 each year.
When you factor in the expenses to own the property and the difference in interest charged and rent, you have a loss of -$4,500. The loss on the investment property is then deducted from the taxable income.