---
title: "Negative Gearing Has Three Levels. Most Investors Are Stuck on Level One."
description: "90% of Australian property investors understand negative gearing wrong. The depreciation clawback at sale is real — but the maths still works in your favour. Here's why."
author: Yan Zhu
date: 2024-06-27
category: Finance & Tax
url: https://premiumrea.com.au/blog/negative-gearing-three-levels-every-investor-must-know
tags: ["negative gearing", "tax strategy", "depreciation", "capital gains tax", "property investment", "ATO", "tax deductions"]
---

# Negative Gearing Has Three Levels. Most Investors Are Stuck on Level One.

*By Yan Zhu, Co-Founder & Chief Data Officer at PremiumRea — 2024-06-27*

> Your accountant told you negative gearing saves tax. That's Level One. What they probably didn't mention is that the ATO wants some of it back when you sell. That's Level Two. Level Three is where the real money is.

I'm going to tell you something that'll make your accountant uncomfortable.

Negative gearing — the tax strategy that's practically a national sport among Australian property investors — is widely misunderstood. Not by beginners. By everyone. Including people who've been claiming it for a decade.

The misunderstanding has three layers, and each one changes how you should think about your investment strategy. Most investors never get past the first layer. A smaller group discovers the second layer and panics. The third layer is where the actual maths lives, and it's where rational decisions get made.

I've spent the better part of eight years pulling apart property tax structures. My background is actuarial science — risk quantification is literally what I was trained to do. And what I can tell you is that negative gearing is neither the miracle your mortgage broker sold you, nor the trap that property sceptics claim.

It's a tool. And like any tool, the outcome depends entirely on whether you understand what it actually does.

## Level One: The tax refund everyone talks about

Here's the version you've probably heard.

You buy an investment property. The rent doesn't cover your costs — mortgage interest, rates, insurance, management fees, maintenance. The shortfall is your "loss." Under Australian tax law, that loss gets deducted from your other income, reducing the amount of tax you pay [1].

Let's run the numbers with a real scenario.

George earns $150,000 a year. He buys an investment property for $700,000, borrowing 80% at 6% interest. His annual numbers look like this:

- Rental income: $30,000 ($577/week)
- Mortgage interest: $33,600 (6% on $560,000)
- Rates, insurance, management: $6,400
- Depreciation (building + fixtures): $10,000
- Total costs: $50,000
- Net loss: $20,000

That $20,000 loss gets deducted from George's $150,000 salary. He's now taxed as if he earned $130,000. At his marginal rate of 39% (including Medicare levy), that's a tax saving of roughly $7,800 per year [2].

Sounds brilliant. You lose $20,000 on paper but the government gives you $7,800 back, so your real out-of-pocket cost is only $12,200. And your property's growing in value the whole time.

This is where most investors stop thinking. This is Level One.

And it's incomplete.

## What happens when you sell? (Level Two — the part nobody mentions)

Here's where George's chicken drumstick stops tasting so good.

When you sell an investment property, the Australian Taxation Office calculates your capital gain based on your "cost base" — which is your original purchase price minus all the depreciation you've claimed over the years [3].

Read that again. Minus the depreciation.

George bought his property for $700,000. Over ten years, he claimed $100,000 in building and fixture depreciation. His cost base isn't $700,000 anymore. It's $600,000.

If he sells for $900,000, his capital gain isn't $200,000 (sale price minus purchase price). It's $300,000 (sale price minus adjusted cost base).

The depreciation came back. The ATO gave it to you as a tax deduction each year, and now they want it accounted for in your gain. This is what accountants call the "depreciation clawback" [4].

When investors discover Level Two, they often react in one of two disastrous ways:

1. They stop claiming depreciation entirely — forgoing $5,000 to $10,000 in annual tax refunds because they're spooked by the eventual clawback
2. They hold the property forever, terrified of triggering the capital gains event

Both reactions are financially irrational. And they're based on a misunderstanding of Level Three.

## Level Three: Why the maths still works in your favour

Here's the part that only about 2% of property investors properly understand.

The depreciation clawback only applies to depreciation — the paper loss from building wear and tear. It does not apply to your actual cash expenses. The mortgage interest, rates, insurance, and management fees you deducted? Those are genuine costs you paid in real money. The ATO never claws those back [5].

Let's finish George's story.

Over ten years he claimed $100,000 in depreciation. But he also claimed approximately $120,000 in genuine cash expenses (the difference between his total costs and his rental income, minus depreciation, across ten years). Those real-money deductions saved him roughly $46,800 in tax over the decade — money in his pocket, permanently.

Now he sells for $900,000.

Capital gain: $900,000 minus $600,000 (adjusted cost base) = $300,000.

But here's the kicker: because he held the property for more than twelve months, he qualifies for the 50% CGT discount [6]. His taxable gain is $150,000, not $300,000.

So the $100,000 depreciation that got "clawed back" only actually increases his tax bill by $100,000 × 50% (CGT discount) × 39% (marginal rate) = roughly $19,500.

He got $100,000 in depreciation deductions over ten years, which saved him approximately $39,000 in tax (at his marginal rate). And at sale, he gave back $19,500.

Net benefit of claiming depreciation: roughly $19,500 — even after the clawback.

> "The depreciation clawback is real, but the maths is not symmetric," says Yan Zhu, Co-Founder & Chief Data Officer at PremiumRea. "You get the deduction at your full marginal rate every year. You give it back at half rate because of the CGT discount. That asymmetry is the entire game."

And that's before we factor in the time value of money. A dollar saved in tax today is worth more than a dollar paid in tax ten years from now. At even a modest 3% inflation rate, those $39,000 in deductions received over the decade are worth approximately $45,000 in today's terms, while the $19,500 paid back in year ten is worth about $14,500 [7].

The real net benefit, adjusted for time value: approximately $30,000.

## So who should actually use negative gearing?

Not everyone. And this is where I differ from most property commentators who treat negative gearing as universally good or universally bad.

Negative gearing makes sense when three conditions are met:

**Condition 1: Your marginal tax rate is 37% or higher.** That's taxable income above $120,000 [8]. Below this threshold, the tax benefit shrinks rapidly. At a 32.5% marginal rate, the annual saving from a $20,000 loss is $6,500 — barely enough to justify the hassle and cash flow stress.

**Condition 2: The property has genuine capital growth potential.** Negative gearing is a bet. You're accepting short-term losses in exchange for long-term gains. If the property doesn't grow, you've just lost money with a partial tax refund as consolation. This is why we insist on 80% land-to-price ratios — it maximises the likelihood that your capital growth outpaces your holding costs [9].

**Condition 3: You have a plan to become positively geared.** The best negative gearing strategies are temporary. Buy the property negatively geared, add value (renovation, granny flat, rent restructuring), and transition to positive cash flow within two to three years. The tax deductions cover your costs during the transition period. After that, the property funds itself.

If you can't meet all three conditions, there are better strategies. Positive cash flow from day one via dual occupancy or rooming house conversion. Or rentvesting — renting where you want to live while investing where the numbers work.

## The depreciation schedule you're probably not getting

One practical note that saves our clients thousands every year.

Every investment property should have a tax depreciation schedule prepared by a qualified quantity surveyor [10]. Cost: $600 to $800. The schedule documents every depreciable item in the property — from the building structure itself (depreciable at 2.5% per year for properties built after 1987) to fixtures like carpets, blinds, hot water systems, and ovens (depreciable at varying rates, typically over 5 to 15 years) [11].

The first-year deductions from a proper depreciation schedule on a typical Melbourne house built in the 1980s to 2000s range from $8,000 to $15,000 [12]. That's $3,000 to $5,850 back in your pocket at a 39% marginal rate. From a single document.

> "I've lost count of the number of clients who come to us managing investment properties with no depreciation schedule," says Yan Zhu. "They're leaving $3,000 to $5,000 on the table every single year. Over a decade, that's $30,000 to $50,000 in tax refunds they never claimed."

The depreciation schedule is ordered once and used for the life of the property. It's the single highest-ROI expense in property investing, and roughly half of all investors don't have one.

## The bottom line on negative gearing

Negative gearing is not a strategy. It's a tax treatment that applies when your investment property costs more to hold than it earns. The strategy is what you do with it.

Level One investors treat the annual tax refund as the goal. They buy negatively geared properties and hold them forever, content with $7,000 a year from the ATO while their property may or may not be growing.

Level Two investors discover the clawback and either panic-sell or stop claiming depreciation — both of which are worse than doing nothing.

Level Three investors understand the asymmetry: deductions at full marginal rate in, clawback at half rate out, with time value working in your favour. They claim every deduction available, get a proper depreciation schedule, plan their exit to maximise the CGT discount, and — critically — they have a strategy to transition from negative to positive cash flow within three years.

The property isn't the strategy. The tax isn't the strategy. The strategy is buying the right asset, improving it, and using the tax system to subsidise your holding costs while you do.

## References

1. [Australian Taxation Office, 'Rental Properties 2021 — Claiming Deductions', 2021. Deductible expenses for investment property owners.](https://www.ato.gov.au/individuals/investments-and-assets/residential-rental-properties/)
2. [Australian Taxation Office, 'Individual Income Tax Rates 2021-22'. Marginal rates including Medicare levy.](https://www.ato.gov.au/Rates/Individual-income-tax-rates/)
3. [Australian Taxation Office, 'Capital Gains Tax — Calculating Your CGT', 2021. Cost base adjustments for depreciation claimed.](https://www.ato.gov.au/individuals/capital-gains-tax/)
4. [Australian Taxation Office, 'Capital Works Deductions — Disposal of Rental Property', 2021. Depreciation adjustment to cost base upon sale.](https://www.ato.gov.au/individuals/investments-and-assets/residential-rental-properties/rental-expenses-you-can-claim/capital-works-deductions/)
5. [Treasury, 'Tax Expenditures Statement 2021'. Analysis of negative gearing benefit distribution by income bracket.](https://treasury.gov.au/publication/p2022-244657)
6. [Australian Taxation Office, 'CGT Discount for Individuals', 2021. 50% discount for assets held >12 months.](https://www.ato.gov.au/individuals/capital-gains-tax/cgt-discount/)
7. [Reserve Bank of Australia, 'Statement on Monetary Policy', November 2021. CPI and inflation forecasts used for time value calculations.](https://www.rba.gov.au/publications/smp/2021/nov/)
8. [Australian Taxation Office, 'Individual Income Tax Rates 2021-22'. 37% marginal rate applies to taxable income $120,001-$180,000.](https://www.ato.gov.au/Rates/Individual-income-tax-rates/)
9. [PremiumRea Investment Framework, 2021. Minimum 80% land-to-price ratio for capital growth optimisation.](#)
10. [Australian Institute of Quantity Surveyors, 'Tax Depreciation Schedules — Guidelines for Investment Properties', 2021.](https://www.aiqs.com.au/)
11. [Australian Taxation Office, 'Rental Properties — Decline in Value of Depreciating Assets', 2021. Division 40 and Division 43 depreciation rates.](https://www.ato.gov.au/individuals/investments-and-assets/residential-rental-properties/rental-expenses-you-can-claim/decline-in-value-of-depreciating-assets/)
12. [BMT Tax Depreciation, 'Average First-Year Depreciation Deductions by State', 2021 Annual Report. Victoria average: $9,400.](https://www.bmtqs.com.au/)

---

Source: https://premiumrea.com.au/blog/negative-gearing-three-levels-every-investor-must-know
Publisher: PremiumRea (Optima Real Estate) — Melbourne buyers agent