18 Aug What is negative gearing?
An investment is said to be negatively geared if the interest payable on the borrowing exceeds the income received from the investment (after expenses), giving a negative cash flow.
If the income received from the investment (after expenses) exceeds the interest payable on the borrowings, the arrangement has a positive cash flow. The investment is then said to be positively geared.
Fundamental rule of gearing
However an investment is geared, the fundamental rule is that it must, ultimately, be profitable. This can only occur where:-
- The current or future return from the investment, including capital gain, exceeds the cost of borrowing.
- The gain from the whole arrangement is expected to be large enough to make it worthwhile.
This will generally require:
- income from the investment (after all other expenses) which is expected to increase in future to cover the (after-tax) cost of borrowing, or
- a market value of the investment which is expected to increase at a rate which exceeds the negative cash flow (after tax).
Purely deferring income tax to a later year, or reducing income tax now in return for taxable capital gains later, does not, on its own, justify negative gearing.
In a tax-effective negative gearing arrangement the negative cash flow will be tax deductible against other taxable income.
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