Gearing Made Simple

Gearing - we hear the word “gearing” thrown around in relation to mortgages and investment properties, yet many know little about gearing debt – Often our only knowledge about gearing is in relation to our car! Let me put the concept of gearing debt in simple terms:

Gearing refers to the debt used to purchase an asset, such as an investment property. A property is said to be “geared” if you have a loan attached to it, and can be either negatively or positively geared.

NEGATIVE GEARING

Negative gearing means that the costs associated with owning an investment property are greater than the income (usually, rent) that the property generates. In this situation when costs are greater than income, the difference is a “loss”. A loss can provide you with tax savings, as fundamentally the loss will reduce your other income, such as your wage and salary, which reduces the amount of tax you pay.

For example, let’s consider Anna who owns one investment property from which she receives $25,000 in rent annually. Anna has costs associated with this property, including mortgage interest, agent fees and rates, and they total $30,000. The difference between the two amounts is a $5,000 loss, which Anna uses to reduce the tax payable on her salary.

POSITIVE GEARING

Positive gearing is simply the opposite. Positive gearing occurs when the income that a property generates is greater than the costs associated with owning the property.

To illustrate positive gearing, let’s consider the situation of Anna’s sister, Jane, who also owns an investment property. Jane also receives $25,000 in rent each year, but for Anna the costs associated with owning the property are only $20,000. Therefore, Jane receives a profit of $5,000 from her investment property which is deemed as additional income. As this profit is taxable, Anna needs to pay tax on the $5,000 income from her positively geared property.

You might think that Anna’s negatively geared situation is better because her taxable income is reduced and she pays less tax, whereas Jane’s positively geared situation brings in additional income and pays more tax. However, a loss is still a loss for Anna, and the whole point of investing is to make money at some stage.

Contact me on 0413 246 820 if you’d like to learn more about gearing a property.