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A 101 Guide to Negative Gearing
Negative Gearing 101
Negative gearing has become a frequently-used investment strategy for reducing the holding costs on investment properties. But how exactly does it work? Here's what you need to know:
What is Negative Gearing in regards to investment property?
"Gearing" is a term that relates to how a person manages the income and expenses of any given investment, this includes stocks and shares. In terms of property, gearing can either be positive or negative. Positive gearing is when borrowing occurs for investment purposes, and that property creates a positive income flow. Negative gearing is when borrowing occurs for investment purposes, but that property creates a negative income flow, or a net loss that is can be claimed as a tax offset.
How can losing money be smart?
Investing in property is an important financial decision in terms of being integrated into a grater strategy that is designed to meet a person's short and long-term financial goals. It's a strategy that should take in both a person's current and future financial position and circumstances.
An investor might incorporate negative gearing into their overall financial strategy as a means to lower their taxable income, while still building wealth through what may be future or potential capital growth. This means that by claiming a tax offset on current income can lower a person's tax bracket and lead them to paying less taxes overall.
High-income earners are particularly well-disposed to use negative gearing as a way to build long-term wealth by leveraging the tax department to help with funding the investment. This only makes sense though if the property investment is forecasted to generate positive income flow in the incoming years. This could be done by recovering initial losses through later rental increases or reduced tax payments, but also by selling the property at an increased rate to cover losses.
Like any investment scenario, there are pitfalls to negative gearing. This is a long-term financial strategy and should only be used if the investor is able to sustain the shortfalls in the immediate future. Risks such as potential tenant vacancies should be considered, and property should be chosen for location.