Negative gearing is one of those terms that is frequently mentioned in discussions about property investment and taxation in Australia. For some, it’s a smart wealth-building strategy. For others, it’s a source of confusion. Let’s break it down so you can understand what it means and how it works.

What is gearing?

“Gearing” simply refers to borrowing money to invest. This could be in property, shares, or other income-producing assets.

• Positive gearing happens when the income you earn from the investment (like rent) is more than the expenses of owning it (like loan interest, rates, and maintenance).
• Negative gearing is the opposite: your expenses are greater than the income from the investment, leaving you with a net loss.

How does negative gearing work?

Let’s use a property example. Imagine you buy an investment property and rent it out. You receive $25,000 a year in rent. But the costs of owning the property add up to $35,000 (loan interest, rates, insurance, repairs, etc.).

That means you’ve made a $10,000 loss for the year.

Because the property is income-producing, the Australian Tax Office (ATO) allows you to offset that $10,000 loss against your other income, such as your salary. If you earn $80,000 in wages, your taxable income is reduced to $70,000.

This reduces the amount of tax you pay and can make a significant difference at tax time.

Why do people use it?

On the surface, it may sound odd that people would deliberately take on a money-losing investment. The strategy makes sense when investors are banking on two key factors:

1. Tax benefits – the immediate relief of reducing taxable income.
2. Capital growth – the expectation that the value of the property (or other investment) will rise over time.

In other words, investors are often willing to accept short-term losses if they believe the property will appreciate sufficiently in value to generate long-term profits.

The risks of negative gearing

While negative gearing can be beneficial in certain circumstances, it’s not without its risks:

• Cash flow strain – you still need to cover the shortfall between rent and expenses. If your financial situation changes, this can become difficult.
• Interest rate changes – rising interest rates can increase your losses, making it harder to sustain the strategy.
• No guarantee of capital growth – if property values stagnate or fall, you could end up with both a loss on paper and no growth in value to offset it.

Who does it suit?

Negative gearing is generally more attractive to higher-income earners. That’s because the tax benefits are greater when you’re in a higher tax bracket. For lower-income earners, the benefit may not outweigh the cash flow pressure of covering losses.

Negative gearing is a legal and commonly used tax strategy in Australia. At its core, it allows investors to reduce their taxable income by offsetting investment losses. However, it comes with real financial risks and isn’t suitable for everyone.

If you’re considering negative gearing, it’s essential to look beyond the tax savings and assess whether the investment stacks up overall. Speaking with an accountant or financial adviser can help you determine whether it’s the right approach for your situation.