Reveka is a builder. She doesn’t own a business, but works for someone else.
Over the years, she’s saved up enough money to buy a trendy apartment in a slowly gentrifying outer suburb as an investment. The existing tenants pay around $20,000 a year in rent.
Reveka started out with a 15% deposit. This means she’s highly geared (in debt) and is facing a large annual interest bill of $25,000.
She has around $4,000 in expenses, too – including rates, insurance, body corporate fees, repainting the front room, and fixing the garage door.
Overall that’s a loss of $9,000 a year, which affected her pre-investment purchase lifestyle. But this isn’t as bad as it seems.
Reveka could use this $9,000 loss to reduce her taxable income – and by extension – reduce her tax bill. However, the tax rebate on this loss would only get realised at the end of the financial year (unless she applies to have her PAYG withholding varied).
With her tax rate at 33 per cent, let’s assume that Reveka can offset the $9,000 against her taxable income. This brings her tax bill down by $3,000. Now her out-of-pocket costs are only $6,000.
Given her ultimate goal of long-term capital growth, Reveka's comfortable making a $6,000 loss each year.
This is an example of negative gearing. While it’s a more complicated investment strategy, it can be a solid long-term option.