Property

If you were to key “negative gearing” into Wikipedia – and, let’s be clear, you should never get your investment advice from Wikipedia – you’d get three short and rather dismissive paragraphs.

But if you then followed the link on that page to “negative gearing (Australia)”, you’d get 2600 words of technical and even moral discussion and debate. There is truly nowhere else in the world that is so obsessed with the idea of negative gearing as Australia.

But what does it mean, and is it right for you?

Simple concept

Negative gearing is a simple enough concept: if the costs of owning a property – including the interest on your loan and the usual maintenance and repair work – are greater than the income you get from that property, then by definition you are negatively geared.

In Australia, a whole industry exists around encouraging you to do exactly this, for tax reasons. Generally speaking, if you’re making a loss on your property, you can set that against your tax.

Specifically, you can (in some circumstances) make deductions in three areas: revenue, including interest on the loan as well as maintenance, agent fees, council charges, body corporate, insurance and bank costs; claims for capital items, such as white goods; and for building allowances. (These last two categories get you into the world of depreciation, which is a whole other subject – basically, the gradual deterioration in value of assets, from your fridge to an extension you’ve built on your house, can be turned into a tax deduction spread out over many years, subject to specific depreciation schedules that the Tax Office sets.)

An absurd situation

Negative gearing is quite popular in Australia, despite the fact that in most countries (Canada and New Zealand are exceptions) it is not an accepted practice, and the fact that most people in other parts of the world think it patently absurd to engineer a situation in which you’re making a loss on purpose. Its popularity in Australia stems from the fact that taxes are high and pervasive here, so anything that can reduce that bill can, in some circumstances, make sense.

The plan goes like this: as you pay your mortgage month after month, your equity in the property increases, until one day you sell it at a major capital gain – having not incurred tax bills along the way in building your investment.

Anyone considering it must be aware that this situation comes with a significant risk.

For a start, you’re borrowing to invest; that’s always hazardous because it has the potential to increase both gains and losses.

Vulnerable

Second, if you’re negatively geared, then you’re already putting yourself in a position where you have to be able to meet your losses on the investment somewhere else. You need to be very sure that source is going to be resilient, because if it isn’t, you’re not going to be able to meet repayments on your property. And – this is perhaps the point that is most easily overlooked – by negatively gearing, you have already made yourself vulnerable; if things change, such as the loss of a tenant, or a decline in your asset value, or a sudden rise in interest rates, you become even more at risk. You must be sure that your finances will be able to withstand such variations. One way to improve your standing in this respect is mortgage protection insurance, or landlord cover, or some combination of the two.

Negative gearing doesn’t relate only to property. For example, it can also apply to sharemarket investments.

The principles are the same, and these words of advice from ASIC’s consumer site, moneysmart.gov.au, are worth remembering: “Tax benefits alone are not a good enough reason to gear an investment. To profit from negative gearing, you must turn this yearly loss into a profit sometime in the future. If  you aren’t sure of this, the investment is really not worth your time.”