DEFINITION of 'Negative Gearing'

Negative gearing is a form of financial leverage and is commonly used in the context of property investing. Negative gearing involves borrowing money to buy an income producing asset, such as a rental property, when the asset won't be able to produce enough income to cover the loan payments, cost of maintenance, interest, or depreciation in the short term. Ideally, the asset will eventually produce enough money to cover those costs. These losses can be beneficial to the owner's tax bill in certain instances. Depending on the investor's home country, the shortfall between income earned and interest due can be deducted from current income taxes. Countries that allow this tax deduction include Canada, Australia and New Zealand. Investing in such a way might make sense in instances where large capital gains are expected at the time of sale which make up for the intermittent losses.

BREAKING DOWN 'Negative Gearing'

Negative gearing occurs when an investor purchases an income producing asset using a loan, and the income produced by the asset cannot cover the loan payments or other expenses associated with the asset. Negative gearing most often occurs in rental properties, where the rental income received isn't enough to cover the loan payments, interest costs on borrowings, plus expenditures toward property maintenance and upkeep.

Negative gearing only becomes a profitable venture when the property is eventually sold, and a prerequisite is that property values are rising, not falling or holding steady. If property values are falling or holding steady, it is difficult to sell the asset for the gain necessary to make up for the losses while the asset was held and not producing income to cover expenses. Many investors who speculate this way will purposely seek out negative gearing for the tax deductions in the hope that they will make a profit when the property is sold for a capital gain.

Investors considering this type of arrangement need to have the financial stability to fund the shortfall out of pocket until the property is sold and the full profit can be reached. Also of utmost importance is that the interest rate is locked in from the beginning or, if the borrower's interest is calculated on a floating index, that prevailing rates remain low.

RELATED TERMS
  1. Capital Gearing

    Capital gearing refers to the amount of debt a company has relative ...
  2. Income Property

    An income property is property bought or developed to earn income ...
  3. Investment Property

    An investment property is a real estate property purchased with ...
  4. Form 4797

    Form 4797 is a tax form distributed by the Internal Revenue Service ...
  5. Investment Interest Expense

    If proceeds from a loan are used to invest in stock, the interest ...
  6. Property Management

    Property management is the administration of residential, commercial ...
Related Articles
  1. Taxes

    How to Prevent a Tax Hit When Selling a Rental Property

    Rental property ownership has its benefits, but when selling you can face a big tax hit. Thankfully, there are ways to reduce your capital gains exposure.
  2. Financial Advisor

    How to Reduce Real Estate Investment Taxes

    Real estate tax law is not the same for rental properties as it is for residences. These tips can help you pay less in taxes.
  3. Investing

    What You Should Know About Real Estate Valuation

    Accurate real estate valuation is important to mortgage lenders, investors, insurers, and buyers and sellers of real property.
  4. Investing

    Tips for prospective landlords

    Investing in rental property can generate serious income, but there's more to it than collecting rent. Check out all the pros and cons before you invest in the rental property.
  5. Taxes

    Tax Breaks for Second-Home Owners

    Owning a second home is a great investment for a variety of reasons, but you need to know the tax implications of multi-home ownership.
  6. Investing

    4 ways to value a real estate property

    Here are several approaches to evaluate real estate properties for investment purposes.
  7. Taxes

    10 Things to Know About 1031 Exchanges

    Real estate swaps grow popular, but traps are many. Here's 10 things to know when considering 1031 swaps. Also: Beware new rules on vacation homes.
  8. Investing

    Getting a Mortgage vs. Paying Cash for Investment Properties

    Is it better to pay for investment property with cash or to take the leveraged approach? We break down the pros and cons of each approach.
  9. Investing

    Considering a Rental Property? 3 Questions to Ask

    If you’re considering a rental property there are three questions you should ask yourself first.
RELATED FAQS
  1. What is a good or bad gearing ratio?

    A gearing ratio measures a company's financial leverage. Although gearing ratios vary by industry, there are some guidelines ... Read Answer >>
Trading Center