Product Code Database
Negative gearing is a form of financial leverage whereby an investor borrows money to acquire an income-producing investment and the gross income generated by the investment (at least in the short term) is less than the cost of owning and managing the investment, including depreciation and interest charged on the loan (but excluding capital repayments). The investor may enter into a negatively geared investment expecting tax benefits or the capital gain on the investment after it is sold to exceed the accumulated losses of holding the investment. The investor would take into account the tax treatment of negative gearing, which may generate additional benefits to the investor in the form of tax benefits if the loss on a negatively geared investment is Tax deduction against the investor's other taxable income and if the capital gain on the sale is given a favourable tax treatment.
Positive gearing occurs when one borrows to invest in an income-producing asset and the returns (income) from that asset exceed the cost of borrowing. From then on, the investor must pay tax on the rental income profit until the asset is sold, at which point the investor must pay capital gains tax on any profit.
When the income generated covers the interest, it is simply a geared investment, which creates passive income. A negative gearing strategy makes a profit under any of the following circumstances:
The investor must be able to fund any shortfall until the asset is sold or until the investment becomes positively geared. The different tax treatment of planned ongoing losses and possible future capital gains affects the investor's final return. In countries that tax capital gains at a lower rate than income, it is possible for an investor to make a loss overall before taxation but a small gain after taxpayer subsidies.
Some countries, including Australia and Japan, allow unrestricted use of negative gearing losses to offset income from other sources. Several other OECD countries, including the USA, New Zealand, Germany, Sweden, Canada and France, allow loss offsetting with some restrictions. Applying tax deductions from negatively geared investment housing to other income is not permitted in the United Kingdom or the Netherlands. "Quarantining Interest Deductions for Negatively Geared Rental Property Investments" [2005] With respect to investment decisions and market prices, other taxes such as stamp duty and capital gains tax may be more or less onerous in those countries, increasing or decreasing the attractiveness of residential property as an investment. Housing and Housing Finance: The View from Australia and Beyond, RBA [2006]
A negatively-geared investment property will generally remain negatively geared for several years, when the rental income will have increased with inflation to the point that the investment is positively geared (the rental income is greater than the interest cost).
The tax treatment of negative gearing (also termed "rental loss offset against other income") varies. For example:
Negative gearing continues to be a controversial political issue in Australia and was a major issue during the 2016 Australian federal election and the 2019 Australian federal election, during which the Australian Labor Party proposed to eliminate the tax-deductibility of negative gearing losses against non-investment income (with some exceptions), and to halve the capital gains tax discount to 25%. Analysis found that negative gearing in Australia provides a greater benefit to wealthier Australians than the less wealthy.
Federal Treasurer at the time, Scott Morrison, in defence of negative gearing, cited tax data that showed that numerous middle income groups (he mentioned teachers, nurses, and electricians) benefit in larger numbers from negative gearing than finance managers.
Between 1997 and 2007, the Tax Law Rewrite Project changed this system by simplifying the schedules. As with the previous system, people would not be allowed to transfer incomes (or losses).
A UK government online resource on renting out property in England and Wales Renting out your property (England and Wales) outlines how to offset losses. It states that losses can be offset against "future profits by carrying it forward to a later year" or against "profits from other properties (if you have them)".
The Rental Income Guide IRD - Rental income IR264 states a loss can only be deducted against other incomes if the rental income is at market rate.
The Opposition Labour Party attempted to raise negative gearing in the 2011 election, but after their failure to win government the issue reduced in significance. NZ moves to quarantine negative gearing
New Zealand now has ring-fencing rules, abolishing negative gearing in the residential property market. Residential property deductions can only be made against residential property income and cannot be deducted from income from other sources, e.g. wages.
Personal business expenses may always be deducted from personal business income. If those expenses exceed business incomes (i.e., the business is losing money for tax purposes), the resulting "non-capital loss" may be deducted from other personal incomes, so long as the Canada Revenue Agency (CRA) believes that it is a genuine business (and not a personal activity being used to generate tax losses). CRA Income Tax Audit Manual This loss may also be carried back up to 3 years, or carried forward up to 20 years, to offset income earned in those years. CRA - Non-capital losses of other years
Interest paid on a loan can be treated as a business expense, so long as the money was borrowed to generate income.
Claim the following carrying charges and interest you paid to earn income from investments: ... Most interest you pay on money you borrow for investment purposes, but generally only if you use it to try to earn investment income, including interest and dividends. However, if the only earnings your investment can produce are capital gains, you cannot claim the interest you paid. CRA Line 221 - Carrying charges and interest expenses
You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.It is possible to deduct any loss against other incomes, depending on a range of factors. Rental Income and Expenses - Tips for Schedule E
Individuals can claim losses against rental loss with minimal restrictions, Analysis of Income (use for real estable income) but if the property was owned through a partnership or trust there are restrictions. The Japanese taxation of real estate income for individuals
There are a number of additional rules, such as restricting claims of losses due to Bad Debt. Additional information can be found in the Japan Tax Site.
Germany recognises seven sources of income: The German tax System
The income from each of these sources is calculated separately.
Rental income is taxed as income and is subject to the progressive tax rate. Interest on loans provided to finance real estate, expenses, and property-related cost (e.g., management fees, insurance) can be deducted from the taxable rental income. German Tax Overview
If real estate is held as private assets (i.e. not as a business asset), the gain from the sale of a property after a holding period of more than 10 years is generally tax-free respectively does not constitute taxable income. §23 German Income Tax Act However, there are exceptions to this rule, e.g. it is assumed that the sale of three "objects" (individual properties, real estate or rights equivalent to real estate) within 5 years constitutes a business activity and that the income generated from the sale is therefore business income and not possibly tax-exempt "other income". German federal court decision on the distinction between private asset management and commercial property trading
Dutch resident and non-resident companies and partnerships owning Dutch property are in principle allowed to deduct interest expenses on loans from banks or affiliated companies, and property-related costs from their taxable income. Real Estate Going Global Netherlands
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