Positive gearing is a situation where the income generated from an investment property exceeds the expenses associated with owning it. This is a favourable position for many investors as it means the property is not only covering its costs but also generating additional income. However, this additional income is subject to taxation, which is an important aspect investors must manage.
Positive Gearing and Taxation
When an investment property is positively geared, the net income generated is added to the investor's taxable income and taxed at their marginal tax rate. This means if your rental income exceeds the sum of your mortgage interest, property management fees, maintenance costs, and other allowable deductions, the surplus is taxable. It's crucial to account for this when planning your investment strategy, as the additional income could push you into a higher tax bracket.
A common misconception is that positive gearing automatically results in a loss of benefits. In reality, while you'll pay tax on the surplus income, the benefits of having a self-sustaining property and the potential for capital growth often outweigh these costs.
How This Works in Practice
Consider a 3-bedroom house in Geelong, purchased for $700,000. If the annual rental income is $40,000, and the total annual expenses (including mortgage interest, property management fees, and maintenance) are $35,000, the property generates a net income of $5,000. If you are on a 37% marginal tax rate, this results in an additional tax of $1,850. Despite the tax, you still have a net gain of $3,150.
Professional Insight
In our experience, the benefits of positive gearing often extend beyond immediate cash flow. One thing we frequently see is investors focusing solely on the tax implications without considering the long-term capital growth potential. What most investors don't realise is that a positively geared property can provide a buffer against interest rate rises or unexpected vacancies, making it a more resilient investment. Another pattern is the tendency to overlook potential deductions that can further improve net returns, such as depreciation on plant and equipment under Division 40.
When Does the Answer Change?
When Should You Seek Professional Advice?
It's advisable to consult with a Chartered Quantity Surveyor and an accountant to navigate the complexities of positive gearing. Your marginal tax rate, property location, and personal financial circumstances can all influence the outcome. Professional advice ensures you maximise both your cash flow and tax position, tailored to your specific situation.