In property owner and real estate investment circles, the terms positive and negative gearing have been frequently tossed around. Some investors are firm believers in pursuing positively geared properties only; others argue that it’s more financially savvy to diversify your portfolio and incorporate a couple of negatively geared properties into the mix.
Despite what people may tell you, there isn’t one right answer here. So much depends on the individual property, as well as the particular investor’s financial status.
You’ll have to sort through a number of independent variables with your clients, but this article offers a basic overview of the advantages and disadvantages of positive- and negative-gearing properties.
Positively geared properties
By definition, a property is positively geared when the owner receives more for rent than what it costs to satisfy all other expenses, including mortgage payments, interest, property maintenance, taxes, and other overhead costs.
When purchasing a rental property, the majority of investors are only interested in positively geared properties. However, it’s not uncommon for market fluctuations to turn a promising investment into a negatively geared property.
Also referred to as cash-flow properties, positively geared properties are advantageous for a number of reasons, including:
- Income. The greatest benefit of a cash-flow property is the monthly income. A positively geared property provides another stream of income that can be used to offset expenses, build a retirement account, or almost anything.
- Easier loan process. Lenders tend to be much more attracted to a property if the investor can prove that it will be positively geared. This accelerates the purchasing process and eliminates unnecessary delays.
However, positively geared properties can have disadvantages, as well.
- Taxable income. Money earned on a cash-flow property is taxed like any other income. This could push the investor into a higher tax bracket.
- Slow growth. Investors have to look beyond the numbers and determine why the property is positively geared. Often, such properties are located in a volatile neighborhood and may be prey to an uncertain future.
Negatively geared properties
What about properties whose operating expenses and payments are higher than the rental income they can generate? Any number of factors can create a negative cash-flow property, so it’s worth understanding the financial implications for the investor.
Contrary to what many believe, there are advantages as well as the negatives. Take a look at the potential positive aspects:
- Tax deductions. The biggest benefit of owning a negatively geared property is that an investor is able to claim extra tax deductions. Ultimately, this could lower the total taxable income.
- Capital gains. Negatively geared properties can typically be purchased at below-market values. This gives the buyer a better chance of receiving a healthy return when he or she decides to sell.
But of course, there are also a few negatives here:
- Negative cash flow. The monthly losses are the most obvious disadvantage. Not every investor can afford to give up hundreds or thousands of dollars per month.
- Slow development. All too often, it can take years or even decades for a negatively geared property to achieve its potential. Many investors can’t wait that long.
Always proceed with caution
In most cases, it’s going to make sense for you to target positively geared properties. But there are situations in which it might make financial sense to pursue a negatively geared property to offset tax liabilities and other expenses.
This handy negative gearing calculator tool is a great way to see fairly quickly what the net income effect of taking on a new property would be. As an accountant, your best piece of advice is going to be to proceed with caution.
There are instances in which either positively and negatively geared properties will offer advantages and disadvantages. All you can do is state your considered opinion and leave the rest to your client.