What Is Negative Gearing?
Let me explain negative gearing to you directly—it's a common practice in property investing, essentially a form of financial leverage where you buy an income-producing asset like a rental property, but that asset doesn't generate enough income to cover its costs right away. For instance, if the rental income falls short of covering loan payments, maintenance, interest, or depreciation in the short term, you're in negative gearing territory. Ideally, over time, the asset will start producing enough to cover those expenses.
You might wonder why anyone would do this. The key reason is that those short-term losses can actually help reduce your tax bill in certain situations, depending on where you live.
Key Takeaways
- Negative gearing is a form of financial leverage typically seen in the context of property investing.
- A negatively geared asset is one that does not produce enough income to cover its cost at the moment.
- An investor who is negative gearing expects to gain from tax benefits in the short term and to eventually sell the asset at a higher price to make up for the initial losses.
- Negative gearing only becomes a profitable venture when the property is eventually sold.
Understanding Negative Gearing
To understand this better, a negatively geared asset simply doesn't provide enough income to cover its ongoing costs, which means you're dealing with a loss as the owner. The upside for you as the buyer or investor is that, based on your country's tax rules, you can often deduct the difference between the income earned and the interest or expenses from your current income taxes.
Countries like Australia, Japan, and New Zealand allow this deduction without much hassle. Others, such as Canada, France, Germany, Sweden, and the United States, permit it but come with restrictions you need to be aware of. This approach makes sense if you're anticipating large capital gains when you sell, which can offset those ongoing losses.
Profiting From Negative Gearing
Here's the reality: negative gearing turns profitable only when you sell the property and benefit from capital appreciation. For that to happen, property values must be on the rise—not falling or staying flat. If values drop or stagnate, you won't be able to sell at a price high enough to recover the losses from the period when the asset wasn't covering its expenses.
Many investors deliberately pursue negative gearing for those tax deductions, betting they'll turn a profit through capital gains at sale time.
Special Considerations
If you're thinking about this strategy, you must have the financial stability to cover the shortfall out of your own pocket until the sale brings in the full profit. It's also critical to lock in your interest rate from the start or ensure that if it's floating, rates stay low.
One common criticism you should know about is that negative gearing can distort the housing market by reducing the supply of rental properties, potentially driving up rents, and encouraging excessive investment in real estate.
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