Negative Gearing

Negative Gearing

What is negative gearing?

Negative gearing is a financing strategy most commonly used in property investment. An asset is described as negatively geared when the income it generates (for example, rent) is less than the ongoing costs of owning it (mortgage interest, maintenance, insurance, depreciation, etc.). The result is an ongoing cash loss for the owner.

Investors use negative gearing when they expect the asset’s capital value to rise over time and, in some jurisdictions, to gain tax advantages from deducting the short-term loss against other income.

How it works (simple example)

• Annual rental income: $18,000
• Annual expenses (interest, maintenance, taxes): $24,000
• Annual loss (negative gearing): $6,000

If local tax rules allow, that $6,000 shortfall can be deducted from the investor’s taxable income, reducing current tax liability. The investor’s plan is that future capital gains on sale will more than offset the accumulated cash losses.

Tax treatment and geography

Tax treatment varies by country:
– Some countries (for example, Australia, Japan, New Zealand) allow the full deduction of rental shortfalls against other income.
– Others (including Canada, France, Germany, Sweden, and the United States) permit deductions but often with restrictions or different rules regarding what can be claimed.

Always consult local tax rules or a tax professional—deductibility, depreciation schedules, and capital gains taxation differ and materially affect outcomes.

When negative gearing can be profitable

Negative gearing becomes profitable if:
– The property appreciates enough that the capital gain on sale offsets the accumulated cash losses and taxes.
– The investor benefits from current tax deductions that improve short-term cash flow after tax.
– Financing costs remain manageable (fixed or low variable interest rates).

Success depends on rising property values, the length of time held, and tax and financing conditions.

Risks and special considerations

• Cash-flow burden: Investors must be able to cover the shortfall until sale or until the property becomes cash-flow positive.
• Interest-rate risk: Rising rates increase the cost of borrowing, worsening the shortfall for variable-rate loans.
• Market risk: If property values fall or stagnate, there may be no capital gain to offset losses.
• Opportunity cost: Money used to service losses could be deployed elsewhere.
• Policy and tax risk: Governments can change rules on deductibility or capital gains taxation.
• Market effects: Critics argue negative gearing can reduce rental supply, push up house prices and rents, and incentivize over-investment in real estate.

Who might consider it

• Investors with stable other income who can absorb short-term losses.
• Those confident in long-term capital appreciation in the target market.
• Investors who have assessed tax rules and financing risk and have contingency funds.

Quick checklist before using negative gearing

• Verify local tax rules on deducting rental losses and capital gains treatment.
• Model realistic rental income and all ownership costs, including potential vacancies.
• Stress-test scenarios for interest-rate increases and property price stagnation or decline.
• Confirm you have sufficient cash reserves or income to cover ongoing shortfalls.
• Consider alternative investments and their expected return, risk, and liquidity.

Summary

Negative gearing is a strategy that accepts short-term cash losses on an income-producing asset, typically to obtain tax benefits and aim for long-term capital gains. It can be profitable under the right market, tax, and financing conditions, but it carries significant cash-flow, market, and policy risks. Proper due diligence, financial capacity, and tax advice are essential before pursuing this strategy.