Negative gearing

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Negative gearing is a form of leveraged investment in which an investor borrows money to buy an asset, but the income generated by that asset does not initially cover the interest on the loan (interest > income). In a few countries the strategy is motivated by taxation systems that permit deduction of losses against taxed income, and tax capital gains at a lower rate. When income generated does cover the interest it is simply a geared investment which creates a source of passive income.

A negative gearing strategy makes a profit under the following circumstances:

1. If the asset rises in value so that the capital gain is more than the sum of the ongoing losses over the life of the investment; or

2. If the income stream rises to become greater than the cost of interest (i.e. the investment becomes positively geared); or

3. If the interest cost falls due to lower interest rates or paying down the principal of the loan (again, making the investment positively geared).

The investor must be able to fund any shortfall until the asset is sold, or until the investment becomes positively geared (income > interest). 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 an investor 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 is permitted in several countries, including Canada, Australia and New Zealand. A negatively geared investment property will generally only remain negatively geared for several years, after which the rental income will have increased with inflation to the point where the investment is positively geared (the rental income is greater than the interest cost). Positive Gearing occurs when you borrow to invest in an income producing asset and the returns (income) from that asset exceed the cost of borrowing. From this point in time, 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 sale profit.[citation needed]

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