If you have plans to invest in rental property, gearing is a strategy you need to know about. It simply means borrowing money to buy a given property. Gearing can be both positive and negative. However, many investors are oftentimes concerned about negative gearing because of the implications it has on taxes as well as the investment altogether. If you are new to property investment, especially negative gearing, here are a few things worth knowing about it.
What It Entails
Negative gearing is basically a strategy that involves generating short-term to medium-term losses, particularly tax losses, and then leveraging them to maximise exposure to expected losses as well as gains. That is, negative gearing is a situation where the income you generate from the rental property every year is less than the cost of owning it (the expenses incurred in buying and maintaining the property). This means the investment will be creating a taxable loss, which, fortunately, you can offset against any other income you have, such as a salary.
Negative gearing comes with some advantages. The most obvious benefit is that you will be able to pay less in taxes because of the ability to use the property investment loss (taxable loss) to offset your income. The higher the taxable income, the higher the tax bracket, so if you are a high-income earner, the ability to save tax makes negative gearing an ideal strategy. You can also be entitled to a myriad of tax deductions with this strategy.
There are some risks involved in negative gearing. First, it is important to understand that negative gearing is more of a tax strategy. That is, while you can still offset your taxable loss against your income, reducing tax payable on your salary for instance, you will still be making a loss on your property investment. If these losses are extremely large, they can be detrimental. This is why before you commit to gearing your property investment negatively, you need to consider whether you have enough cash flow or a reliable income to effectively manage the investment when situations change. For instance, if the interest rates increase and you have to deal with increased repayments, when you lose your job, or when the value of your investment drops.
There is also the risk of vacancy where not all the units in your property are rented out. This will definitely result in reduced income, so to prevent or minimise the impact of such outcomes, always be keen on the location of the property you are negatively gearing in. You need the property to be in high demand so consider one that is close to some of the major social amenities such as roads for ease of transport. A property that is close to a major road for instance, will be more visible to potential tenants than one in a remote area.