Citation: 2010 TCC 432
Date: 20100823
Docket: 2008-3653(IT)I
BETWEEN:
MARQUITA MARTINELLO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Boyle J.
[1]
The taxpayer, Marquita Martinello,
owns three modest 20’x22’ rectangular wooden 1½ storey Nova Scotia homes. She has owned them and rented them out for many years. With the
exception of 2005, they have always generated positive net rental income. The
issue in this case is whether the costs of certain repairs in 2005 to one of
the homes damaged by tenants and by a hurricane strength storm and related
water and moisture damage were deductible as current expenses or were required
to be capitalized. There is no dispute as to the costs of the work done.
[2]
The homes are similar.
The one in question was built in the 1970s and purchased by the taxpayer in the
1980s for $20,000 to $25,000. It does not have a foundation beyond concrete
footings and granite blocks upon which the floor sills and joists sit.
[3]
The taxpayer’s husband
was in the building business in his working years and had generally been
responsible for maintaining the properties over the years. Mr. Martinello
was the taxpayer’s only witness and acted as her agent with some assistance
from his daughter. Mr. Martinello’s testimony was complete and forthright,
well‑organized and clearly presented. I accept all of his testimony
without hesitation.
[4]
In 1996 the Martinellos
took out a mortgage of approximately $15,000 to make improvements to the pre‑rental
homes. The windows and doors were replaced and the plumbing and wiring were
updated. These costs were capitalized by the taxpayer.
[5]
No other improvements
were made to the properties and they only required regular ongoing maintenance
as well as cleaning and painting between tenants. These were attended to by the
Martinellos themselves without significant expense.
[6]
In October 2004 a
substantial hurricane strength storm caused significant damage to the property
rendering it uninhabitable for a time. The winds had rocked or lifted the house
off its foundation somewhat and caused the main wooden floor beam or sill to
give way. Not surprisingly, the dampness over the years had weakened the sills
and joists exposed to the earth below. This in turn caused much of the rest of
the floor to fall in and joists, also weakened by dampness over the years, to
break or give way. In addition, the storm waters rushed in underneath the
house. Much of the floor and parts of the sidewalls were left sitting in the
mud. The storm also blew down the old chimney which was no longer being used.
[7]
The property had also
suffered some tenant wear and tear and damage which needed to be attended at
the same time. Mr. Martinello was no longer young enough to do the needed
work himself but he did oversee it.
[8]
The most significant
repair expense related to the floor. The house was cribbed and jacked up. The
existing footings were straightened and reinforced with some more cement. The
silt and dirt and debris were removed. New floor sills and joists were needed
to replace the old. New floor boards were used where necessary. This part
required a Repairs Permit from the town of Shelburne which approved “House being lifted and repaired to sills and floor.”
[9]
While the house was
raised the bottom foot or so of the walls was also replaced by cutting off the
rotted end and bracing a patched length of new stud.
[10]
When the house was set
back on the foundation, the existing house plumbing had to be reconnected to
the existing sewer line. The water pump and tank under the house were repaired
and some new parts were needed because the electric pump was damaged by the
water and wet soil.
[11]
The electrical supply
to the house was turned off for the repairs and had to be reconnected. The
inspector ordered that the house’s wiring (which had previously been replaced)
had to be replaced because of the risk of extensive corrosion damage to wiring
under the floors and at the bottom of the walls.
[12]
The fallen chimney was
fully removed and the roof and walls patched. That half of the roof was
reshingled with asphalt shingles. The old aluminium siding that was salvageable
was reused in the gable ends of the house and new inexpensive vinyl siding was
used to clad the bottom of the house. Damaged soffits and fascia were
reinstalled and replaced. The length of vinyl eavestrough on that side of the
house was either put back up or replaced.
[13]
Inside, the bottom foot
or two of the downstairs walls were replaced with new wallboard. The wall where
the chimney stood was also patched with masonite or wallboard. The mud and debris
were taken out and the inside was repainted where needed. When the existing
wooden lower kitchen cupboards were reinstalled, the floor of one cupboard had
to be replaced with a new board due to rot.
[14]
The small attached
wooden mud room at the back entrance and the modest wooden deck sitting low to
the ground had to be replaced.
[15]
Photographs of the
repaired home were put in evidence. The Martinellos spent considerable time and
money repairing the home to its original rentable condition. It is clear that
Mr. Martinello is of the generation often marked by considerable
frugality. Their rental property which had suddenly become uninhabitable
returned to be habitable. Since the repairs it has been rented out profitably
at the same rent as before and the same rent as their other two rental homes.
Their somewhat tired and run‑down looking old house had become a patched
up tired and somewhat run‑down looking old house that seemingly could not
be rented out for any more than it had been previously.
[16]
All of these repairs
were the result of either tenant damage, normal wear and tear, depreciation or
deterioration of the house over the time it was rented out, or storm damage
while it was rented out. The repairs did not improve the house beyond its
original condition in any manner. The municipal tax fair market value assessments
for the years before and after 2005 are substantially unchanged. In these
circumstances, I am satisfied that the costs of these repairs and maintenance,
though all done at once, were properly deductible as current expenses and are
not required to be capitalized. Current deduction best matches the expenditures
to the revenues generated from the house while it was deteriorating or damaged.
[17]
It is clear that the
Canada Revenue Agency’s (“CRA”) concerns were triggered by the fact that the
taxpayer had obtained a GST New Housing Rebate on the cost of the repairs on
the basis the home was substantially renovated. While it seems clear that these
repairs probably did not qualify for the new home GST rebate, making a house
habitable again after it has become suddenly uninhabitable can be a significant
project which in common parlance would be considered a substantial renovation.
Further, the CRA auditor who testified acknowledged that, because the house was
rented out, the landlords’ repairs would probably have qualified for a
comparable GST rebate in the circumstances in any event.
[18]
The CRA auditor who
testified indicated she had been the GST auditor reviewing the Martinellos’ GST
rebate claim. After speaking with Mr. Martinello, she allowed the GST
rebate claim. However in the course of reviewing the taxpayer’s GST claim, she
accessed Mrs. Martinello’s income tax returns and noted that these repairs
had resulted in a rental loss for the year whereas prior years were profitable.
She therefore made a “lead” to income tax audit that the loss may be the result
of improvements that should have been capitalized. The CRA auditor then joined
income tax audit and was assigned to audit her own lead. I am quite surprised
that the CRA permits auditors to audit their own lead. Clearly this auditor
having already decided the work qualified as a substantial renovation for
purposes of the GST new housing rebate could only be expected to conclude that
the expenses should have been capitalized. For that she cannot be faulted.
However, a different auditor with fresh eyes might have realized after further investigation
and discussion with Mr. Martinello that the costs should not have
qualified for the new home GST rebate but would be currently deductible for
income tax purposes.
[19]
Mr. Martinello had
consulted the CRA by telephone and received the CRA Rental Income Guide. He understood
that, as stated in the Guide, “[a]n expense that simply restores a property to
its original condition is usually a current expense. . . ” and
that “[t]he cost of repairing a property by replacing one of its parts is
usually a current expense.” The Guide goes on to give the example of a house’s
electrical wiring system being such a part of the house. Clearly the taxpayer
in this case did no more than restore the house to its previous condition.
[20]
The cases referred to
by the respondent are not comparable. Each of Albayate et al. v. The Queen,
2008 TCC 24, 2008 DTC 2536, Fiore et al. v. The Queen,
93 DTC 5215 (FCA), referred to in Albayate, and Nguyen v.
The Queen, 2007 TCC 574, involved expenses incurred to repair a
property after it was acquired and before it was used by the taxpayer to
produce income. It is obvious that such expenses should ordinarily form part of
the capital cost of the property. The property was being put in rentable
condition for the first time.
[21]
Similarly, in Fotherby
v. The Queen, 2008 TCC 343, 2008 DTC 4186, the fire and
hurricane damage occurred before the taxpayer decided to put the property to a
particular income‑producing purpose. In each of Leclerc v. Canada,
[1998] 2 C.T.C. 2578 (TCC), and Speek (P.) v. Canada, [1994] 2
C.T.C. 2422 (TCC), referred to in Fotherby, the extensively fire‑damaged
houses had been demolished and new houses constructed. It is obvious in such a
case that the cost of a new house should be capitalized (and presumably the
capital cost of the demolished house resulted in a terminal loss).
[22]
Mrs. Martinello’s
appeals are allowed with costs.
Signed at Ottawa, Canada, this 23rd day of August 2010.
"Patrick Boyle"
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