What is positive gearing and how does it work?

While many people have heard of negative gearing as an investment strategy, positive gearing tends to be less well known. Simply put, positive gearing happens when the rental income from an investment property is greater than its expenses, including the interest on any loan taken out to buy it.

Read on to learn more about this investment strategy, as well as its benefits and drawbacks.

What is positive gearing?

Positive gearing is an investment strategy involving borrowing to buy an investment property whose rental income is greater than its interest and property holding and maintenance costs.

For example, if a landlord was collecting more money in rent than they were spending on mortgage interest repayments, insurance, property maintenance, rates and any other costs, it is likely the property would be positively geared.

How does positive gearing work?

• A property is positively geared if the expenses are less than what is gained through rent.
• Although investors with a positively geared property end up with more income, they also need to pay tax on this income.
• Positive gearing is the opposite of negative gearing. Negative gearing occurs when property expenses are greater than the amount the landlord is collecting in rent, and the resulting loss may be able to be offset against the landlord’s other personal income, such as employment income.

How much tax do you need to pay on a positively geared property?

Although investors with positively geared property end up with more income after paying investment property expenses than those with a negatively geared investment, they will probably need to pay tax on this income.

The amount of tax paid depends on the income earned as well as the investor’s highest personal tax bracket (i.e. their marginal tax rate). More information about tax rates can be found via the Australian Taxation Office (ATO) website.

How much tax do you get back from negative gearing?

According to treasury.gov.au, your investment property is negatively geared if your deductible expenses are greater than the income you earn from the property.

If this is the case, you may be able to deduct your investment loss against your other income, such as salary and wages, reducing the overall amount of tax you have to pay. If your income is not enough to absorb the loss, you may be able to carry the loss forward to your tax return in the following year.

As with positive gearing, the amount by which you can reduce your tax will depend on your marginal tax rate.

How does the market influence positive gearing?

Positive gearing tends to be more prevalent in periods of low interest rates and/or strong rental demand.

When demand for rentals is high, the cost of leasing typically goes up – putting more money into the landlord’s pocket and making it more likely the property will be positively geared.

Likewise, low interest rates can also contribute to the probability of positive gearing through lowering the interest component of investment property mortgage repayments.

Is positive gearing a good or bad idea?

There is no definitive answer to whether positive gearing is a good or bad idea. Instead, its suitability as an investment option should be examined on a case-by-case basis, with careful consideration to the pros and cons. Professional advice should also be sought as required.

Pros and cons of positive gearing

Can you positively gear your own home?

In the context of property investment, "gearing" typically refers to the act of taking out a loan to buy a property which you intend to rent out to tenants. The phrases "positive" and "negative" then refer to the status of its net income.

Given this definition, it would be impossible to positively gear your own home, and claim its expenses as a tax deduction, unless you turned it into an investment property.

However, you might be able to positively gear a holiday home, apportioning expenses on the basis of rental weeks vs personal use weeks.

Positive gearing vs negative gearing

While both investment methods involve taking out a loan to invest in property, they tend to have different outcomes. This, however, does not necessarily make one better than the other.

Generally, a property is positively geared if the expenses are less than what is earned by the investor in rent. Likewise, a property is negatively geared if the opposite is true: more money is paid in expenses than what is made in rent.

There are, however, benefits to both methods; and while some investors may swear by one over the other, others may suggest a portfolio made up of both positively and negatively geared property to harness the perks of each.

Generally, negatively geared properties have a greater chance of capital growth whereas positively geared properties can carry less risk and result in more income.

An example of positive gearing

Tom is a nurse who has been saving for a house deposit for the past five years.

With $100,000 saved, he begins his property search. Soon, he discovers the houses near the hospital are out of his price range.

Tom values living close to work, but he also wants to enter the housing market. He decides to buy an investment property instead, using an investment property home loan, and keeps renting close to work.

He settles on a house in an outer suburb with a price tag of $500,000 and puts down his savings as a 20% deposit. He locks in a fixed interest rate of 3.29% p.a. for five years on an interest-only loan, and begins paying $1,097 per month in loan interest repayments.

After settlement, Tom finds tenants reasonably quickly. They agree to pay $2,000 per month in rent. This is more than the $1,595 per month he estimates he will spend on mortgage interest, maintenance costs, insurance, council rates and other property expenses combined.

Based on these figures, Tom’s investment property is positively geared. His property income will exceed his expenses by $405 per month. Although he will have to pay tax of around $140 on this income, he will still have a positive cash flow of $265 per month to put towards his own rent.