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Property investment strategies: Negative v positive gearing
The term “gearing” refers to borrowing money or taking out a loan to buy an investment asset. This strategy is usually employed by property investors, but the type of gearing they utilise depends on how they want their income and expenses to circulate.
Property investment strategies: Negative v positive gearing
The term “gearing” refers to borrowing money or taking out a loan to buy an investment asset. This strategy is usually employed by property investors, but the type of gearing they utilise depends on how they want their income and expenses to circulate.
Some investors choose to let the property take care of itself through neutral gearing – when rental income is only enough to pay for the overall expense of holding the property. However, many investors choose between positive and negative gearing.
What is positive gearing?
Also known as “cash flow properties”, a positively geared property refers to purchasing an investment property that generates an income that is larger than its overall expenses – including loan interest and principal payments.
Buying a positively geared property is profitable for an investor since they can use the generated income to pay for expenses related to holding the property, as well as accumulate funds from the excess cash to grow their portfolio.
If the property is situated in an area where real estate values are increasing, the property itself may increase in value, and this may generate a capital gain for the investor once they sell the property.
Investors may consistently generate a profit from the rental income; however, the profit they receive must be included as part of their assessable income – and they must pay tax at their effective marginal tax rate.
What is negative gearing?
Negative gearing refers to buying an investment property that generates a larger loss compared to the income derived from it. That is, the total sum of expenses – from maintenance to loan repayments – exceed the income the property generates.
The question now is: if expenses exceed income, why would investors choose to buy a negatively geared property investment? The answer lies in two potential benefits of negative gearing that investors may claim.
Reason #1: Investors may claim a tax loss against their assessable income and this lowers the amount of tax they have to pay when they file their tax return. In some cases, the tax savings can exceed the income loss from the negatively geared property.
Reason #2: If the real estate market where the property is situated rises, so too would the value of their property. If the market delivers strong growth, their property’s capital appreciation may be able to offset the losses incurred while they held the property, and they may generate a large profit once they sell the property.
Negative gearing as an investment strategy
Despite income losses, investors choose to employ negative gearing for their investment strategy as a way to minimise their tax payable annually. However, experts remind investors that it is not advisable to invest in property solely for tax purposes.
Only investors with enough income to cover the losses the property would incur should consider executing a negative gearing strategy.
It may be wiser for an investor to consider how they would meet the expenses should interest rates rise or their main source of income is compromised before investing in a negatively geared property.
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