In the world of real estate you hear the terms positive and negative gearing being frequently used. When you purchase a property you will soon know after a time period if its positive or negatively geared! So it makes sense to want to know what this means. In this article you will learn the meaning of these terms, what the differences are and how both can be played to your advantage!
What is Gearing?
The word gearing refers to any money that is borrowed or lended for investment purposes. This is seen commonly if you seek finance from the banks in order to purchase real estate.
What is Positive Gearing?
Positive gearing is when the income or revenue from your investment is more than the expenses of the investment. Depending on your individual opinion having a positively geared investment (property in particular) is ideal. That surplus of money is now yours! What you choose to do with the money is completely up to you! It can go towards supplementing your income or go into further investing and compounding your money! However the only downfall is that the surplus of money is considered earned income on your behalf so is therefore taxed come tax time.
What is Negative Gearing?
Knowing what positive gearing is, I am sure you can guess what negative gearing is! For clarification, negative gearing is where your expenses and the money you owe is more than the money you are making off the investment. You may be wondering why people would choose to have a negatively geared property for example (rental income is less than what you owe back + expenses). This is because people can accept a negatively geared investment if they believe that in future the investment (property for example) will increase substantially in value therefore pay its dividend.
How negative gearing can be good!
Don't get me wrong in my opinion I would much rather have a positively geared investment opposed to a negatively geared one. However, there is one bonus of having a negatively geared property and that is the tax benefits (depending on country, seek further expertise to see if this is available in your country). For example if the income from the property is $1000 a month but the expenses from owning the property is $1200 a month that $200 can be claimed off your taxable income.
This is where there is a debate on whether having a negatively geared property can actually be good. People with high income earning jobs have been known to buy heavily negatively geared properties in order to decrease their taxable income. You may think that that's just a waste of money! However they think of it as instead of the tax man taking their money they are putting it towards an asset hence still have control over that money.
How and why houses go from negatively to positively geared
When you buy an investment property, you will come to terms quickly whether it is a positively geared or negatively geared property. If you find yourself with a negatively geared property don't think that this is forever! Properties can start out negatively geared, but as a few years go by it can change to positively geared. How does this happen you may ask. Well, basically your income off the property increases overtime and in general your expenses should decrease. As a landlord and the owner of the rental property you have the option to increase the rent every year (and most do!.) Landlords increase the monthly rent they charge due to factors such as their property value increasing, inflation, help cover unexpected costs or simply because they want more money in their pockets at the end of the month! As the landlord they have the right to do all of this! This all obviously increases the income made off their property investment.
Over time as well your expenses should in general decrease. This happens due to the principal of your loan decreasing due to repayments so therefore the interest you have to pay back on the principal will be less.
There is also another tax benefit that comes in general when owning an investment rental property which is that yearly you are allowed to take the value of depreciation of the property off your taxable income. There is much more depth among that topic but for now know that the depreciation of your property can be tax deductible. This is why investing in property can become very appealing to investors.
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