If you’ve ever heard your mates, work friends or politicians on TV ever talk about ‘negative gearing’ or ‘positive gearing’ and you had no idea WTF it meant but just nodded along, we’ve got you!

Positive and negative gearing might make you think of gears, tools and mechanic-y things, but they actually refer to investing in property.

‘Gearing’ means you’re borrowing money for investment purposes. So if you’re taking out a credit card, you’re not gearing. But borrowing money for an investment property? That’s geared.

Got the gearing.. But what does it mean to be ‘positive gearing’?

Positive gearing means that the income from your investment property is more than the costs associated with maintaining your property (excluding principle loan repayments).

For example, let’s say Jess bought a unit in Victoria, it’s her first investment property.

Jess’ brought in some tenants to the property who are paying $700 a week in rent.

Jess’ got some costs she’s gotta pay to keep up her property. Think: 

• interest on her mortgage repayments
• management fees
• repair costs
• insurance etc. 

These costs are a total of $650 a week.

Since Jess’ costs ($650) is less than the rent ($700), Jess can cover the expenses of her property with her rental income and have an extra $50 per week left over.

That means Jess’ property is ‘positively geared’.

How does tax work with positive gearing?

Jess’ earning some boss income on her investment property which, just like any source of income, will be subject to tax at her marginal tax rate.

But, the good news is Jess’ costs to maintain her investment property are tax deductible expenses.

This reduces her taxable income from $700 to $50, meaning Jess only needs to pay tax on the $50 profit.

In other words, Jess’ investment property rental return is higher than the costs associated with her property.

Got it! So, what’s ‘negative gearing’ then?

Negative gearing works in the opposite way. 

The idea was introduced in 1985 to encourage Aussies to invest in property. It’s when the rental income from an investment property is lower than the deductible costs of owning that property.

And this sounds bad, right? But here’s the trick. The government offers some tax deductions for this type of investment.

And this is a VERY popular strategy used by Australian property investors. In fact, nearly 60% of all property investors are negatively gearing their property.

Let’s jump back to Jess and let’s say Jess’ tenants pay $600 in rent, not $700. 

And Jess’ property maintenance costs are still $650. That means Jess’ investment costs are higher than the income she’s generating from the property, and she’s at a loss. Each and every week.

Ummm, but that doesn’t sound great. How’s that a strategy? 

Well that’s where negative gearing gets spicy.

How does tax work with negative gearing?

If Jess makes a loss on her investment property, it can actually be deducted from her total assessable income. And this will reduce her tax obligation.

‍Can’t remember what assessable income is? We’ve got you covered in the Tax Academy.

Let’s say Jess’ only income source is her full time job as a teacher, where she makes $80,000 pre-tax. This is Jess’ ‘assessable income’ for tax purposes. 

The loss from her investment property ($50 a week = $2,600 per year) will be deducted from her assessable income, when her tax is calculated, bringing it down to $77,400 ($80,000 - $2,600).

So even though Jess is making a loss on the property for now, she’s getting tax deductions on her overall taxable income.

And assuming the strategy works out for her, the capital growth on the property over time will eventually outweigh the costs she’s bearing at the moment.

Is one strategy better than the other?

There are advantages and disadvantages to both strategies and investors try to use one or the other depending on their personal choices and circumstances. 

Keep your eyes peeled for part two of this series coming soon on positive and negative gearing where we’ll go into the pros and cons of both strategies.