Offsetting Losses Against Taxable Income: Understanding Negative Gearing
Negative gearing is a concept often discussed in property investment, but it can also apply to other income-producing assets, like shares.
It’s a strategy that allows investors to offset investment losses against their taxable income, potentially reducing their overall tax bill.
Understanding how it works is key for anyone considering property investment as part of their financial strategy.
What Negative Gearing Means
An investment is said to be negatively geared when the costs of owning it — such as mortgage interest, property management fees, maintenance, and other expenses — exceed the income it generates. For example, if an investor earns $20,000 in rental income from a property but pays $25,000 in mortgage interest and related expenses, the investment has a $5,000 loss.
The “negative” part comes from the fact that the investment is operating at a loss in the short term. While this might seem counterintuitive, the loss can provide tax advantages. In Australia, investors can deduct that $5,000 loss from their other taxable income, such as salary or business earnings. This reduces the amount of tax they owe, effectively easing the financial burden of the investment.
Why Investors Choose Negative Gearing
The main reason investors use negative gearing is long-term capital growth. While the property may operate at a loss initially, the hope is that its value will increase over time. When the property is eventually sold, any profit — called a capital gain — can outweigh the earlier losses. Combined with the tax benefits during the holding period, negative gearing can help investors build wealth gradually.
It’s particularly appealing for higher-income earners, as the tax deductions from a negatively geared property reduce taxable income more significantly for those in higher tax brackets. It also helps with cash flow management, as tax savings can partially offset the ongoing cost of holding the property.
A Worked Example
Here’s a simple illustration:
- Rental income: $20,000 per year
- Expenses (interest, fees, maintenance): $25,000 per year
- Loss: $5,000
If your annual salary is $100,000 and your marginal tax rate is 30%, the $5,000 loss reduces your taxable income to $95,000 (bear in mind that this is not the actual tax rate you would be paying).
Your tax saving is $5,000 × 30% = $1,500. So while the property initially costs $5,000 to hold, the after-tax cost is only $3,500. Over time, if the property’s value rises and you sell it for a profit, your capital gains may more than offset these short-term losses.
What To Consider:
Negative gearing isn’t risk-free. Property values can fall, rental income can fluctuate, and ongoing expenses may increase. It’s essential to ensure you can manage the short-term losses without relying solely on tax deductions.
Negative gearing can be a powerful tool for investors who focus on long-term growth and are prepared for short-term losses. By reducing taxable income and potentially enhancing overall returns, it remains a key strategy for many Australians seeking to grow wealth through property or other investments.
Before pursuing a negatively geared investment, speak with a financial adviser or accountant. They can help you understand how it fits your financial goals, assess the potential risks, and determine whether it aligns with your long-term wealth-building strategy.
