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Gearing is simply when you borrow money to invest in an asset. When people are talking about negative gearing in the media, they are usually referring to the practice of borrowing to purchase an investment property. Negative gearing means that the rental return of the investment property is less than the interest payments and other property expenses. Negative gearing losses can be used to reduce your tax bill by offsetting the loss you have on your investment property (the difference between your interest payments and other property expenses and the rental income against your taxable income).
Most investors use negative gearing for the tax deductions available. Negative gearing losses can be used to offset your taxable income, thus reducing the amount of tax you need to pay. Investors also hope that when the property is eventually sold they will receive capital gains by selling the property for higher than they bought it.
Negative gearing involves borrowing money (also known as gearing or leverage) to purchase an investment property. Next, the rental payments from the investment property need to be less than the interest costs and general property upkeep. These losses can be deducted from the investor’s taxable income, reducing the amount of tax the investor needs to pay. As a result of the loss between rental payments and interest payments and other property expenses, this is known as negative gearing. If the opposite occurred, and rental payment was above interest and other investment property related expenditure, the investment would be positively geared.
Suppose you bought a property for $600,000 by taking out a $500,000 loan with an interest rate of 7%. This means that the interest payments are $35,000 annually.
Meanwhile, you are renting out the investment property for $550 a week, which is $28,600 over the whole year.