
How does negative gearing work?
Negative gearing—it’s one of those buzzwords that pops up a lot in conversations about property investment in Australia. But what exactly does it mean, and why do so many investors swear by it?
Some investors swear by it, while others aren’t so sure if it’s worth the hype. If you want the lowdown on how negative gearing really works, what makes it so popular, and whether it’s the right strategy for you, keep reading.
What is negative gearing?
Negative gearing is a strategy where an investor borrows money to purchase a property, but the income generated (usually through rent) doesn’t fully cover the costs of owning and maintaining that property. In simple terms, it means the property is operating at a loss—at least in the short term.
This might sound like a bad deal, but for many investors, it’s a calculated move designed to leverage tax benefits and set up for future gains.
How does negative gearing work?
When you negatively gear a property, you’re using borrowed funds (like a mortgage) to invest. The expenses tied to the property—think mortgage interest, maintenance, property management fees, and council rates—end up being higher than the rental income you receive. This creates a shortfall, or a loss, which can then be used to reduce your taxable income by offsetting it against other earnings like your salary.
The ultimate aim for investors is that, while they’re covering these losses now, the property’s value will appreciate over time. When the property is eventually sold, the profit from that sale (capital gain) should ideally be enough to outweigh the accumulated losses and deliver a solid return on investment. This approach allows investors to maximise tax benefits in the short term while building potential wealth in the long term.
Negative gearing vs. positive gearing
When it comes to property investment, there are two main types of gearing: negative and positive gearing. While they both involve borrowing money to invest, they work in fundamentally different ways and can suit different investor goals.
- Negative gearing: As we’ve discussed, this is when the expenses of owning the property (like mortgage interest, maintenance, and fees) are higher than the rental income you earn. The benefit here is the ability to offset these losses against your other taxable income, potentially lowering your tax bill. The focus is on long-term capital growth; the investor accepts short-term losses in exchange for the possibility of a larger profit when the property appreciates in value and is eventually sold.
- Positive gearing: This is the opposite scenario—your rental income exceeds the costs of holding the property, which means you’re earning a profit straight away. It provides an immediate source of passive income and can boost cash flow, making it attractive for investors who want steady returns without waiting for long-term gains. However, this profit is taxable, meaning you’ll need to set aside funds for the tax you owe.
Pros and cons of negative gearing
Negative gearing can be a powerful tool for property investors, but like any strategy, it comes with both advantages and disadvantages. Let’s break down the key points to help you weigh up the potential benefits against the risks.
Pros of Negative Gearing | Cons of Negative Gearing |
---|---|
Tax Benefits: Reduces taxable income by offsetting property losses. | Cash Flow Challenges: Property operates at a loss, requiring a steady income to cover shortfalls. |
Potential for Capital Growth: Opportunity for long-term profit when the property value appreciates. | Risk of Vacancy: No rental income if the property is vacant, leading to financial strain. |
Contributes to Rental Market: Helps supply housing and stabilise rental prices. | Market Volatility: Property values can stagnate or decline, risking a loss if sold at the wrong time. |
Portfolio Growth: Can leverage existing properties for further investments. | High Costs: Upfront and ongoing costs (stamp duty, maintenance, etc.) can be substantial. |
What do you need for negative gearing to work?
For negative gearing to be successful, certain conditions need to be in place. It’s not a strategy for everyone, and it requires careful financial planning. Here’s what you need to consider:
- Reliable Cash Flow: Since negative gearing involves making a loss in the short term, you need a stable income to cover expenses like mortgage payments, maintenance, and other costs that exceed rental income. Without reliable cash flow, the strategy can quickly become financially draining.
- Long-Term Investment Horizon: Negative gearing is a long-term play, relying on the property’s value appreciating over time. You need to be in a position to hold onto the property for several years, or even decades, to ride out any market fluctuations and wait for an opportune time to sell.
- Selecting the Right Property: Location is key. A property in a high-demand area with good growth potential is more likely to appreciate in value, increasing the chance of long-term profits. It’s also essential to choose a property that will appeal to tenants to minimise the risk of vacancy.
- Risk Management: Given the potential for cash flow challenges and market volatility, having a risk management plan is crucial. This might involve building an emergency fund to cover unexpected costs or taking out insurance to protect the investment. Consulting with a financial advisor can also help tailor your approach to minimise risks.
Is negative gearing right for you?
Negative gearing can be a smart investment strategy, but it’s not without its risks.
Whether you’re searching for rental property management in Perth to expertly handle your existing property, or exploring houses for sale in Perth to kickstart your investment journey, we’re here to support you every step of the way. Our team can provide the guidance and resources you need to make informed decisions and achieve your property goals.
Reach out today to learn more about how we can help!
Related Articles

Perth’s Best Sunday Markets

10 Tips on How to Improve Your Property Value
