Positive Cash Flow and Positive Gearing, What Is The Difference?
“What is the difference between positive cash flow and positive gearing?” and “Is there even a difference?”
This is a question that gets asked a lot by visitors to CashFlow Investor and the answer is yes there is a difference.
This post will explain the difference between to two terms, which of the two is a better investment strategy and at the end of this post I will direct you to some recommended reading if you want to learn more about using these investment strategies for your own financial gain.
What Is Positive Geared Property?
Let’s start with positive geared property because that is the easiest to explain.
Also referred to as positive gearing, positive geared properties are properties that generate a higher income (generally from rental income) than they cost in expenses, before tax is taken into account.
For this example, let’s say you own a $300,000 property with an 80% mortgage at 8% p.a. interest rate. You are paying $19,200/year in interest repayments and let’s assume you are also paying $2,000/year in council and water rates. $500/year in maintenance, $500/year in insurance and $2,500/year in vacancy and rental management fees.
Your total yearly expenses for the property are $24,700.
If your rental income was more than $24,700 each year then this property would be positively geared. Because you would be earning more money in income than you are paying in expenses.
What Is Positive Cash Flow Property?
Positive cash flow property is property that generates a loss (more expenses than income) before tax, but then after tax deductions and refunds are taken into account your income is greater than your expenses.
This can get a little confusing so let’s use the example above (but a little different) to make things clear:
You buy your house for $300,000 and as worked out in the above example your expenses are $24,700. If your rental income is less than $24,700 then you would be making a loss.
But at tax time you may be able to claim $6,000 in tax deductible depreciation. If you are paying 30% in tax then this entitles you to an $1,800 tax refund.
Let’s say you received $23,400 in rental income. You are making a loss of $1,300 on the property. Add in the $6,000 depreciation and your on paper loss is now $7,300.00
If you are paying 30% back then you are now entitled to a $2,190 tax refund.
Your income now goes up to $25,590, which is greater than your expenses of $24,700. Thus after tax your property becomes positive cash flowed.
What Is The Difference Between The Two?
The main difference between the two is that positive geared property generates more income than expenses BEFORE TAX, but positive cash flow property ONLY generates more income than expenses AFTER TAX.
Is One Better Than The Other?
The short answer is no. Different investment plans require different strategies.
The longer answer is that positive geared property (remember that’s positive before tax) is generally better. That is unless you can secure a property in a higher growth area (capital gains growth) using a positive cash flow strategy that you couldn’t get by using a positive geared strategy.
Generally speaking, properties with high depreciation options (such as new properties and newly renovated properties) have the greatest potential to be positive cash flowed. This is because their on paper loss allows you to claim more of your tax refund. However, older cheaper properties can offer a strong rental return and thus be positive geared. So it works for both ends of the spectrum.
Personally I would prefer to be earning money before tax, and using depreciation to pay little to no tax on that income, than to lose money and then have to claim it back.
Recommended Reading About Investing In Positive Property
Explaining the difference between these two terms is just the tip of the iceberg when it comes to investing in positive cash flow/positive geared properties.
It is my suggestion that you continue you research by following the helpful (and free) links below.
Top 10 Positive Cash Flow Property Books Reviewed
10 Places To Find Cash Flow Positive Property (eg. Run down property and high rental return areas)
How To Make Any Property Positively Cash Flowed
Positively Geared Properties, How They Can Make You Financially Free
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