Do you understand negative gearing? I didn’t, until very recently. My excuse is that in Europe (where I come from) not many people have ever heard about it. But even in Australia I’ve met surprisingly many people who know the term but not sure how it works, exactly. There is no shame in not knowing; the shame lies in not finding out – and this post should help you gain a basic understanding about what negative gearing is.
Those of you who weren’t born in Australia, New Zealand or Canada have probably never heard about negative gearing and for a very good reason – this form of leverage is illegal all over the world, except for these 3 countries.
Basically, negative gearing means that you borrow money to buy a property, and the income from the property doesn’t cover your expenses on that property, so instead of making income it makes a loss.
The next logical question is – why would anyone want to make a loss, isn’t investing all about profits? The answer is “capital gains” – the increase in the house value over time. With negative gearing an investor can only make a profit if the house rises in price more than it has lost money until the moment it was sold.
To make negative gearing more attractive there are tax concessions. An investor gets to deduct the losses made on property from his or her income (which could come from any source, not just property) and that way reduce the taxable income, in a way saving money they would have otherwise paid to the government as a tax.
Time for a history lesson: negative gearing was introduced in Australia way back in the early 1980s to increase the supply of rental properties. This way, if more affordable rental houses were available, the government wouldn’t have to fund public housing with all the administrative and infrastructure costs. When the pool of rental properties is larger, the chance that rents will go up is smaller, therefore higher rents won’t drive the inflation up and the economy will be more stable.
But, of course, it’s not all rosy and negative gearing has its dark sides – which I’ll discuss in my next article “What is negative gearing? Part 2″. Stay tuned.
{ 2 comments… read them below or add one }
Yes you are right.
You make it seem evil though, its not such, its just that investors have to top up P/A to cover expenses and the government cover this partly in the tax deductions.
You hit it though that its far cheaper to have investors that it is for public housing….
Matt
Negative gearing may be an attractive option if you are in a higher tax bracket. If you could do an article on Positive Cash Flow or Positive Gearing that would be great – there are still many opportunities where on paper you make a loss but in reality, you break even or even make a profit. Australia is a bit of a haven for real estate investing and as such allow you to claim for depreciation on buildings.