Negative Gearing explained?

Question

I understand that negative gearing is where an investor buys an asset using borrowed funds, and the cost of owning the asset are more then the income from the asset. I'm just having problems understanding how this is an advantage, even if the investor has a decresed tax rate, will this make up the difference in the loss generated by the loan. Surely it won't be enough to actually make a profit. Or is it all just based on the assumption that the asset will increase in value overtime?

Answer 1

I have never heard the term "Negative Gearing".

I do see what you are talking about is a negative cash flow.

I mention this because I think the terms is where your confusion is being created. There is a difference between the "income" an investment makes and the total return.

Since margin interest is deductable against realized gains maybe this is a case where someone is offsetting profits with an investment with negative cash flow.

But cash flow is different from profit and loss. You can't make money by losing it.

Good Luck

Answer 2

first thing first,negative gearings works well when ur country economy is doing well i.e chip companies making  good profits,when inflation under control , when bank interest rates are low and when you have steady job. however negative gearing can be double edge sword during rough times of economy and so on.as you suggested you wont be making any profit but you get a tax relief from the government for the expenses incurred  to create a income. let me give u an example say , u want to buy some xyz shares of a company and u dont have immediate money.option you would choose in this example is take a loan at some interest rate and buy the shares straight away.at the end of each financial year u declare the income generated by xyz(company) like dividends and so and u also declare the expenses incurred to generate income(that is interest rate paid by u to the banks).and the government provides you relief by asking u not to pay tax on expenses incurred dollars.the good thing about this system is u dont pay tax but you feed the banks the same dollars. works well for longterm investment and huge borrowings.but the key thing is not to overcommit yourself just to save couple hundreds of dollars.the idea why government gives u relief is that it knows one day or the other u have to sell the assets and u end up paying cgt(capital gain tax) on the profits u made.in simple words this is governments idea to get more tax money when u sell assets and by providing u some initial relief during purchasing/borrowing times.

hope i did not confuse u.