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To encourage the private sector to invest in property for rental, governments have made available extremely viable tax incentives for the investor. It is through these available tax incentives that investors are able to purchase property at very little cost to themselves and in many cases at virtually no cost to themselves.
Negative Gearing is a tax effective investment strategy. It occurs when you borrow to acquire an investment and the interest and other costs you incur are more than the income you receive. Negative gearing of investment property is used as a means to make it easier to hold property and let it grow in value over time.
The difference between the amount of rent from your property and the expenses related to the property are (assuming there is a loss) tax deductible. There is also provision for non-cash expenses, for example depreciation on items such as light fittings, carpet, building costs, etc. which may increase your available deductions.
If you hold your investment property for long enough, you will hopefully reach the stage where your losses are turning into gains. This occurs for two reasons. First, the rent you are charging will probably rise as it keeps pace with the market value for rents. Second, you and your tenants are steadily whittling the mortgage away and once your rental income exceeds your mortgage repayments you are no longer negatively geared. You may instead be neutrally-geared or positively-geared.
It is essential to use the services of a Quantity Surveyor to ensure you maximise your depreciation deductions. Investors should also use an accountant which specialises in property investment to ensure all tax deductible items are claimed. There are many factors to consider when selecting your property and one of them is new or existing. Purchasing a new property will maximise your tax advantages and reduce the out of pocket costs to you to fund the property. Get the tax man and the rental income pays for your investment property!
At the same time, negative gearing is not for everyone. As it reduces cash flow, it depends for its success on a combination of long term capital appreciation and regular tax advantages. And it is best for people who are comfortable with borrowing.
Positive gearing of an investment property refers to an excess of income, over and above any expenses. The ultimate aim for most property investors would be a portfolio of positively geared properties. Initially however, it is through negative gearing and the associated tax benefits that investors are able to purchase real estate at minimal cost to them.