Negative Gearing

Negative gearing is borrowing to buy an income-producing asset - in practice, almost always an investment property - where the rent does not cover the running costs. The shortfall between the rent and the costs of loan interest, rates, insurance, maintenance, management fees and depreciation is a deductible loss that reduces your taxable income from other sources. A $10,000 shortfall at a 39 percent marginal rate - the 37 percent bracket plus the Medicare levy - trims your tax bill by roughly $3,900.

The term is a political football, but the mechanics are just the tax system. The ATO allows the deductions while the property is genuinely available for rent, and the 50 percent capital gains tax discount on eventual sale is the other half of the strategy. Negative gearing is not a return - it is a subsidy on a loss. The property has to grow in value by more than the accumulated after-tax losses before the strategy pays. Interest-only loans are common in the setup, which keeps the deductible costs at their maximum while the principal stays untouched.

Walk one year. You buy an $800,000 property with a $640,000 interest-only loan at 6 percent: $38,400 of interest. Rent comes in at $650 a week - $33,800 a year - and other costs run $6,200 across rates, insurance, management and maintenance. The shortfall is $10,800, which reduces your taxable income and saves roughly $4,200 of tax at a 39 percent marginal rate. The net annual cost of holding the property is roughly $6,600 after tax - money out of pocket, every year.

The depreciation layer is where the paperwork earns its keep. The building's structure and fittings depreciate under Division 40 and Division 43 of the tax rules, adding a paper deduction that costs nothing in cash each year - a quantity surveyor's depreciation schedule documents it. The ATO requires the property to be genuinely available for rent: a deliberately vacant property, or rents set unrealistically high, forfeits the deductions. The negative gearing calculator runs the full cash flow including the depreciation.

The exit is where the strategy is judged. Selling triggers capital gains tax on the gain, with the 50 percent discount applying to properties held beyond twelve months - the discount halves the taxable gain but not the gain itself. For the strategy to pay, the capital growth has to exceed the accumulated after-tax losses plus the transaction costs of exit. Run the ten-year ledger through the rental property calculator before buying, not after.

For an Australian reader, negative gearing is the most politically argued term in property, and the least understood on its own numbers. The deduction is real: the ATO allows the shortfall against your other income, and the strategy exists because of it. But the deduction is a discount on a loss - saving $4,200 of tax by spending $10,800 of after-tax cash is not arithmetic that pays for itself. The capital gains tax entry covers the discount that applies at the exit. The strategy only works if capital growth outruns the accumulated losses, and MoneySmart's guidance on investment properties treats the tax benefit as one input, not the thesis.

A colleague named Brent (yes, that Brent) bought a $700,000 apartment because the accountant said the refund would be $8,000. He never modelled whether the suburb's growth would outrun the losses the refund was costing him. The refund arrived on schedule; the growth did not. The highest-leverage thing most Australians can do is run the ten-year ledger - costs, growth, exit costs, CGT - through the negative gearing calculator before the auction. Buy the property the numbers support, not the refund the accountant promises.