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Negative gearing

What is negative gearing?

You won’t find the phrase ‘negative gearing’ in tax legislation.

It is a commonly used term used to describe a situation where expenses associated with an asset (including interest expenses) are greater than the income earned from the asset. Negative gearing can apply to any type of investment, not just housing.

Individuals who are negatively geared can deduct their loss against other income, such as salary and wages. This is consistent with the broader operation of Australia’s personal income tax system.

Australia’s tax system operates on the principle that people pay tax on their personal income, less any expenses (called deductions) in generating that income. This is similar to how business profits (that is, income less expenses) are taxed, ie tax is levied on the net profit of a business, not its gross revenue.

Deductions for costs incurred in producing income recognise that different people have different costs in producing income.

If negative gearing essentially means making a loss, why do it?

While making a loss on an investment property or shares might initially seem counterintuitive, some people are willing to do this in the expectation that the capital gain (sale price minus cost of asset) when they sell the asset will more than offset that loss.

Some people might also find themselves unexpectedly in a loss position, if they incur higher expenses or lower returns than anticipated.

Only 50 per cent of the increase in the value of the asset (when it is sold) is subject to income tax, providing it has been owned for more than 12 months.

There are also many non-tax factors that drive people to negatively gear property investment – for example, perceptions about the advantages of negative gearing and a bias towards investing in ‘bricks and mortar’, especially under certain market conditions; both of which might be fuelled by advice from property investment advisers and the media.

Why not link deductions with income from an asset?

Australia’s tax system allows for things like rental income to be added to an individuals’ taxable income in the same way as a small business can add net business income to income from other sources to determine taxable income.

This reduces the costs imposed on the economy from taxing business activities - without changing the incentives to invest.

Compared to a system that links income and deductions to their source, the Australian system reduces these potential distortions to the way

people invest.

Who has negatively geared investments?

In 2012-13:

  • Over 1.9 million people earned rental income
  • Around 1.3 million of these reported a net rental loss
  • Nearly 70 per cent of people with negatively geared property had a taxable income of less than $80,000 per year

Assets like shares can also be negatively geared. In 2012-13, about 270,000 people deducted over $1.2 billion for expenses incurred in earning dividend income.

What is positive gearing?

Positive gearing is when the rental income exceeds expenses. In this situation,

income greater than interest and other expenses is taxed at the individual’s marginal rates.