Negative gearing
Encyclopedia
Negative gearing is a form of leveraged
speculation
in which a speculator
borrows money to buy an asset
, but the income generated by that asset does not cover the interest
on the loan
(Interest > Income). In a few countries the strategy is motivated by taxation systems which allow deduction of ongoing speculative losses against highly taxed income, but tax capital gains at a much lower rate. When income generated does cover the interest it is simply geared investment
which creates a source of passive income
.
A negative gearing strategy can only make a profit
if the asset rises so much in price that the capital gain
is more than the sum of the ongoing losses over the life of the speculation. The speculator must also be able to fund the planned shortfall until the asset is sold. The different tax
treatment of planned ongoing losses and possible future capital gains affects the investor's final return. This leads to a situation in the countries which tax capital gains at a lower rate than income. In those countries it is possible for a speculator to make a loss overall before taxation, but a small gain after taxpayer subsidies.
Deduction of negative gearing losses on property against income from other sources for the purpose of reducing income tax is illegal in the vast majority of countries, the exceptions being Canada, Australia, and New Zealand.
Leverage (finance)
In finance, leverage is a general term for any technique to multiply gains and losses. Common ways to attain leverage are borrowing money, buying fixed assets and using derivatives. Important examples are:* A public corporation may leverage its equity by borrowing money...
speculation
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
in which a speculator
Speculation
In finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
borrows money to buy an asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
, but the income generated by that asset does not cover the interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
on the loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
(Interest > Income). In a few countries the strategy is motivated by taxation systems which allow deduction of ongoing speculative losses against highly taxed income, but tax capital gains at a much lower rate. When income generated does cover the interest it is simply geared investment
Investment
Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
which creates a source of passive income
Passive income
Passive income is an income received on a regular basis, with little effort required to maintain it.The American Internal Revenue Service categorizes income into three broad types, active income, passive income, and portfolio income...
.
A negative gearing strategy can only make a profit
Profit (accounting)
In accounting, profit can be considered to be the difference between the purchase price and the costs of bringing to market whatever it is that is accounted as an enterprise in terms of the component costs of delivered goods and/or services and any operating or other expenses.-Definition:There are...
if the asset rises so much in price that the capital gain
Capital gain
A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor...
is more than the sum of the ongoing losses over the life of the speculation. The speculator must also be able to fund the planned shortfall until the asset is sold. The different tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
treatment of planned ongoing losses and possible future capital gains affects the investor's final return. This leads to a situation in the countries which tax capital gains at a lower rate than income. In those countries it is possible for a speculator to make a loss overall before taxation, but a small gain after taxpayer subsidies.
Deduction of negative gearing losses on property against income from other sources for the purpose of reducing income tax is illegal in the vast majority of countries, the exceptions being Canada, Australia, and New Zealand.
See also
- Negative gearing (Australia)Negative gearing (Australia)Negative gearing is a form of financial leverage where an investor borrows money to buy an asset, but the income generated by that asset does not cover the interest on the loan...
- DebtDebtA debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
- Financial engineering
- InvestmentInvestmentInvestment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...
- Leveraged buyoutLeveraged buyoutA leveraged buyout occurs when an investor, typically financial sponsor, acquires a controlling interest in a company's equity and where a significant percentage of the purchase price is financed through leverage...
- Margin (finance)Margin (finance)In finance, a margin is collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty...
- Return on margin
- Rent seekingRent seekingIn economics, rent-seeking is an attempt to derive economic rent by manipulating the social or political environment in which economic activities occur, rather than by adding value...
- SpeculationSpeculationIn finance, speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum...
External links
- Negative Gearing Issue Sheet for the Australian federal election, 2004
- Australian Taxation Office Rental Properties Guide 2005, product NAT 1729-6.2005
- Real Estate Institute of Australia Policy Statement on Negative Gearing, as of October 2005
- Negative Gearing—A Commentary on how it works and who it is suited to
- Negative Gearing — A Brief Overview of Negative Gearing In Australia and why people choose to do it: (Accountants, Caringbah Sydney, Australia)