If you own an investment property, you've probably faced the 'positive versus negative gearing' debate. So which is best - positive or negative? MPP takes a look.
Thinking positively In simple terms, if you decide to positively gear your property, you’re focused on generating a cash flow rather than on capital growth. Positive gearing is where the rental returns are greater than the outgoings (including interest on the loan). In addition to potentially high rental yields, devotees of positive gearing argue that the cash flow from these properties can be used to fund a whole string of investment properties.
Keys to negative gearing If you decide to negatively gear your investment, keep these three points in mind. Firstly, make sure you purchase a quality investment that is more likely to have a reliable and rising income stream. Secondly, borrow conservatively so you can survive interest rate rises or income losses. And lastly, you’ll have to maintain an income from your job or other sources so you can cover your borrowing costs.
The positives of negatives Yes, negative gearing is in fact the opposite of positive gearing – you’re more focused on capital growth than on generating short-term cash flow, and you reap the taxation benefits accordingly. A negative gearing strategy can make a profit only if the asset rises in value (capital gains) by enough to cover the shortfall between the income and interest which the investor suffers. The investor must also be able to fund that shortfall until the asset is sold. The attraction of negative gearing – where the property’s running costs exceed the rental income – is that ongoing losses are tax deductible. This reduces your tax bill, effectively boosting returns.
A taxing time If you negatively gear a property you will be able to claim your losses on your tax. This is especially useful if you are in the highest tax bracket as you are paying a large proportion of tax on your income. Negative gearing will reduce your income to a lower tax bracket, by making a loss on the month-by-month cost. You can claim this loss in your tax return. Each year you pay interest on your loan, which you are able to claim as an expense along with the other costs incurred during the year, such as property maintenance. You must also declare the income received from the property. The difference will be either a profit or loss – ideally a loss when it comes to tax deductions.
Paying up Positive gearing occurs when the annual rental income received from the property is higher than the annual loan repayments and costs. While you may earn extra income on your investment, this is taxable and must be declared at tax time. You will also have to include the capital gains tax you will have to pay if you decide to sell the property.
Risk and reward Gearing – positive and negative – can be a risky investment strategy. As a general rule, only investors with the financial capacity to absorb the effect of potential falls in investment values as well as an increased cost in interest payments should consider negative gearing. Think about it – in order to make a claim for spending more than you make, you must first have that additional money to spend. You must be able to afford to make a loss – this is an important consideration.
Playing it neutral Just to confuse matters, there is also a thing called neutral gearing. This occurs when an investment’s borrowing cost and other non-capital expenses exactly equal its income. Although the investment’s income is taxable, the borrowing costs are tax deductible. Even after tax, the investor is in a neutral or balanced position. Many investors are willing to forgo the extra tax benefit of negative gearing to reduce their risks in uncertain times through neutral gearing.
It's all about profit Remember that, sooner or later, a good investment must show a profit and not a loss. Keep this in mind when considering an investment property. A good investment should also give you a reliable and rising income. This will reduce your losses over time, and eventually you will expect to pay some tax.
Horses for courses As with all investment strategies, it’s best to talk to your accountant or financial advisor about the strategy most suited to your financial situation. While traditionally the trend has been towards negative gearing, positive gearing is also increasing in popularity, but what is suitable for one investor may not suit another.
If you decide to negatively gear your investment, keep these three points in mind. Firstly, make sure you purchase a quality investment that is more likely to have a reliable and rising income stream. Secondly, borrow conservatively so you can survive interest rate rises or income losses. And lastly, you’ll have to maintain an income from your job or other sources so you can cover your borrowing costs. 
If you negatively gear a property you will be able to claim your losses on your tax. This is especially useful if you are in the highest tax bracket as you are paying a large proportion of tax on your income. Negative gearing will reduce your income to a lower tax bracket, by making a loss on the month-by-month cost. You can claim this loss in your tax return. Each year you pay interest on your loan, which you are able to claim as an expense along with the other costs incurred during the year, such as property maintenance. You must also declare the income received from the property. The difference will be either a profit or loss – ideally a loss when it comes to tax deductions.
Just to confuse matters, there is also a thing called neutral gearing. This occurs when an investment’s borrowing cost and other non-capital expenses exactly equal its income. Although the investment’s income is taxable, the borrowing costs are tax deductible. Even after tax, the investor is in a neutral or balanced position. Many investors are willing to forgo the extra tax benefit of negative gearing to reduce their risks in uncertain times through neutral gearing.
Remember that, sooner or later, a good investment must show a profit and not a loss. Keep this in mind when considering an investment property. A good investment should also give you a reliable and rising income. This will reduce your losses over time, and eventually you will expect to pay some tax.