Borrowing to finance the purchase of an investment property has a number of advantages for the investor.

Among other things, borrowing allows the investor to reduce the amount of equity that he or she has to put into the purchase. Hence for a relatively small outlay, the investor is able to obtain an asset of much greater value. This is called investment leverage.

Any interest on the loan is an income tax deduction. When the interest paid and the other costs exceed the rental income from the property in question, the investment is said to be negatively geared. In these cases, the tax deduction can be used to reduce the tax payable on the investor's other income.

While negative gearing can increase the rate of return, it involves extra risk. Hence it is important for investors to protect themselves appropriately.

The following example illustrates how negative gearing can work for the property investor.

An investor purchases an inner city unit for $130,000 and finances it by an interest-only loan of $117,000 at an interest rate of 8 per cent. The unit is subsequently rented out at $175 per week. The investor has other income and is paying a marginal tax rate of 48½ per cent.

From 1987 to 1998, inner city units showed a capital appreciation of around 10 per cent a year on average.

If the property in question were to match this capital appreciation, the rate of return on the original investment of $130,000 will average 22 per cent a year over a 15-year period.

	income tax
		-	negative gearing: interest + other costs > rent
		-	positive gearing: rent > total costs
	capital gains tax
		-	payable on disposal
		-	only taxes net gain above inflation