"Is Negative-Gearing Really So Great?"

Gearing is a term, and technique used by the financial sector. It is commonly used to finance the purchase of property (real estate or shares).

For example, you have $20,000 you can use as a deposit, and you "gear-up" to purchase property valued at $100,000, by borrowing $80,000…. a legitimate investment strategy, based on sound and logical analysis.

Negative-gearing tends to be most commonly used by promoters of investment products and "tax-schemes", and is sold to investors, based on emotional promises of "reduce your tax; get a big tax refund; let the taxman pay for your rental property" - not frequently based on sound logical analysis.

Let's do an illustration. We'll use "round figures" for simplicity, and choose a rental property as our investment, and will exclude the effects of non-cash items such as depreciation etc.

Annual rental received - 52wks @ $100/w

Outgoings- (such as Management Fees, Rates & Taxes, Repairs & Mtce etc)

Interest on loan ($80,000 @ 7%)

• you may be able to claim a tax refund. In the "best case" scenario, if you were on the top marginal tax rate of 48.5%, you may be able to reduce your tax payable:

ie $3,400 x 48.5%

1,649

• Property appreciating (increasing in value)

1,751

$ 3,400

Consequently, the most important aspect of a negative-gearing arrangement is the potential of your investment to increase in value by at least (in this example) $1751 per annum, with great certainty. Matters of taxation, financing and ownership are of secondary importance.

If you already have a negatively-geared property that has little potential to increase in value, you should either sell it, or pay off your loan to put it into positive gearing.

Positive gearing means that you will show a cash profit. You will pay part of this in tax, leaving surplus cash to put in your pocket. With positive gearing, the need for the property to increase in value is not so important.

As you can see, the loss you carry, is very real, and most of it needs to be funded out of your current weekly/monthly income. It remains a loss, until you re-sell the property.

It is extremely important that you assess :

• the potential for the property to be fully tenanted
• your ability to fund the annual loss (cash shortfall)
• the potential of the property to become positively-geared. That is, to have your income exceed your expenses.
• the potential of the property to continually increase in value. When you are wanting to sell, it should have increased in value sufficient to recoup your annual losses, cover any capital gains taxes, and return you a profit.
• if there is not great certainty of meeting these criteria, your $20,000 deposit could be put to better use.