Negative Gearing is a strategy whereby borrowed funds are used to finance an asset that will pay revenue that is less than its' holding costs. Looking at this concept another way, you make a revenue loss on your investment in order to offset other taxable income that you may have. Let's run through a simple example. Say you buy a house in Hillarys or some other suburb for $500,000. Now you borrow the full $500,000 from the bank at 6.5% per annum and agree with your bank manager to only repay the interest component. Your annual interest cost is therefore $32,500. Now your tenants pay you $500 per week or $26,000 per year. Assuming all your rates, repairs and other associated costs of operation are $4,000, then your total costs of retaining the property in a rentable state is $36,500. Your loss on operating the property is $26,000-$36,500 = $10,500. This loss of $10,500 is the outcome of your gearing i.e. your borrowing to finance a capital asset.

As our tax is a progressive tax i.e. the more you earn the higher your tax on the next $1000 you earn and assuming that you are earning $10,500 above $45,500 but below $80,000, then your $10,500 loss will reduce your taxable income at $10,500x31.5% giving a tax saving of $3,307.50.

Now given that you've recovered tax refunds from the tax man as a result of your negative gearing activity you can take your tax refund and add it to your loss of $10,500 on operations & discover that your actual loss now is only $7,192.50.

Now your property must grow in value by at least $7,192.50 plus the tax associated with the capital gains just to cover your operating loss. Every $ in capital growth will ultimately be exposed to future capital gains tax at whatever your marginal tax rate is in the future. That is unless you have a clever strategy for reducing your capital gains.

Useful definition of Earnings before interest, taxes, depreciation and amortization

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