Jerome A.C.J.:—This is an appeal by the plaintiffs from a decision of the Tax Court of Canada dated July 19, 1990, dismissing their appeal from a reassessment by the Minister of National Revenue for the 1984 taxation year. At the hearing of this matter on February 22, 1994, I allowed the plaintiffs’ appeal indicating these written reasons would follow.
In 1980, the plaintiffs were engaged in the business of manufacturing and selling furniture. In an effort to diversify their business interests, they began to actively pursue and investigate the acquisition of rental property. In December of 1980, Mr. and Mrs. McGovern purchased a three bedroom condominium unit located at Paul Lake, near Kamloops, British Columbia. The condominium, which qualified as a multiple-unit residential building (MURB) under paragraph 1114(a) of the Income Tax Regulations, was purchased for $87,659, financed by way of a cash payment of approximately $12,000 and a first mortgage of approximately $76,000. The monthly payment of principal and interest on the mortgage was $933.
The condominium, situated at the foot of the family ski hill and on the shore of a medium size lake, was ideal for year-round family vacationing. The McGoverns therefore furnished and equipped it with a washing machine, dryer, stove, refrigerator, television and radio in the hope of attracting full families on one or two week stays.
However, in February of 1981, a condominium association was formed in the complex and one of its first steps was to pass by-laws prohibiting short-term rentals by owners. Units were to be owner-occupied or rented to long-term tenants and children under twelve years of age were not to be allowed as residents. The economy of the Kamloops area also suffered a significant decline, including layoffs, high rates of unemployment, high housing vacancy rates and a poor real estate market. As a result of the by-laws passed by the condominium association and the local economic conditions, it became difficult to rent a fully furnished, executive type condominium. The plaintiffs did rent their unit however in 1981, 1982 and 1983 earning income of $3,200, $1,500 and $3,300 respectively. No tenants were found for 1984 and the unit remained vacant. In 1985, the McGoverns lost the property as a result of foreclosure proceedings by the mortgagee.
During the 1981, 1982 and 1983 taxation years, the Minister of National Revenue accepted the purpose of the condominium investment as a rental business and allowed the plaintiffs to claim deductions for expenses and capital cost allowance in respect of the unit. In their 1984 tax return, Mr. and Mrs. McGovern each claimed a loss from the condominium of $6,947.31, being one-half of the following amounts:
Property taxes | $ | 956.62 |
Interest expenses | | 9,575.00 |
CCA Class 8 | | 32.91 |
CCA Class 31 | | 3,330.10 |
| $13,894.63 |
By notice of reassessment dated July 17, 1987, the Minister reassessed the plaintiffs for their 1984 taxation year, disallowing the rental loss claimed by each of them in connection with the condominium. The plaintiffs objected to the reassessment by notice of objection dated October 9, 1987. After receiving notice of confirmation from the Minister, the plaintiffs appealed to the Tax Court of Canada on February 3, 1989. By decision dated July 19, 1990, the Tax Court dismissed the plaintiffs’ appeal from the reassessment of their 1984 taxation year.
The plaintiffs now appeal from that decision on the grounds the Tax Court erred in disallowing the rental loss insofar as the losses claimed in respect of the condominium were incurred for the purpose of gaining or producing income from a business or property. They submit at the time the condominium was purchased, they had a reasonable expectation of realizing a profit from its rental since the location and the unit's features indicated it would be a fruitful business venture. Although the by-laws passed by the condominium association, as well as the poor local economy, made it difficult to rent the unit, the plaintiffs maintain they actively endeavoured to find tenants until they lost the property in 1985.
The Minister submits the claimed rental loss was properly disallowed in respect of the plaintiffs’ 1984 taxation year, since by 1983, they had abandoned any intention of obtaining a profit from the property and made no serious attempts to find a tenant after May of 1983. Furthermore, given the economic conditions of the area, the plaintiffs objectively had no reasonable expectation of making a profit from the condominium. Accordingly, it is argued, the expenses and capital cost allowance claimed by the plaintiffs in their 1984 taxation years with respect to the property were not made or incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), but rather were personal or living expenses.
I am satisfied the plaintiffs’ appeal should be allowed. There is no question the Minister is entitled to disallow losses with respect to a business venture which have been accepted in previous taxation years. Generally, this will occur where the project, which may have initially possessed a reasonable expectation of profit, suffers consecutive losses such as would indicate it has become a losing proposition. However, where the business venture, under normal circumstances, would have realized a profit but fails to do so because of a dramatic change in conditions, a taxpayer should be granted a reasonable period of time in which to ascertain that no income is likely to be earned.
This was the principle applied by the Tax Court of Canada in Aucoin v.
[1991] 1 C.T.C. 2191, 91 D.T.C. 313. In that case, the taxpayer purchased a condominium in Florida for the purpose of earning rental income. He rented the condominium for a one year period at a monthly rental of $750, but owing to a sharp decline in property values throughout Florida, the taxpayer was forced to reduce the monthly rent to $525. Shortly thereafter, Mr. Aucoin attempted, without success, to sell the property but finally decided to withdraw it from the market because of poor real estate market conditions. In computing his income for his 1984, 1985 and 1986 taxation years, the taxpayer sought to deduct rental losses generated from the property which the Minister disallowed on the grounds Mr. Aucoin had no reasonable expectation of profit. In allowing the appeal from the Minister's reassessment, Garon J. made the following comments at page 2195 (D.T.C. 316):
... it would be unreasonable, in my view, to conclude that the appellant ceased overnight to have a reasonable expectation of profit in connection with the rental of the subject property as soon as the slump in the real estate market surfaced. He could have reasonably believed that the drop in the rental market was temporary and there is some suggestion in the evidence to this effect. On the other hand, it would not be realistic for the appellant to expect say, in 1989 to earn income from that property after a string of five years of losses and no real improvement in the market situation. It seems to me that there is a point between these two extremes where a prudent and reasonably informed person would have realized that no income would likely be earned for quite some time from that property. I would believe that point must have been reached two or three years after the occurrence of the drastic change in the real estate market.
[Emphasis added.]
Accordingly, while the Minister is entitled to disallow rental losses which have been accepted in previous taxation years, fairness and consistency require that where there has been a dramatic change in circumstances, a reasonable period of time be granted before such losses are disallowed.
In the present case, there is no question the plaintiffs had a reasonable expectation of profit from rental income when they purchased the condominium. The unit had eminent appeal for that purpose and possessed several attributes which would qualify it for a likely success. It was located on a lake, a small family ski hill facility was right at the back door, it featured a private dock, a freestanding building and was a reasonable distance from the Kamloops market. In fact, the McGoverns managed to rent the unit for the first three years at a reasonable rate. Furthermore, the MURB factor is significant insofar as it rendered the purchase of the condominium an even more sensible and appealing investment for individuals in the situation of these taxpayers.
However, there were sudden and dramatic changes in circumstances beyond the control of the plaintiffs which ultimately led to the demise of the business venture. The by-laws passed by the condominium association made it impossible for the McGoverns to realize their objective of renting the unit to families for one or two week vacation periods. In addition, the economic conditions of the area were severe and unprecedented. The combination of these extraordinary circumstances had a disastrous effect on the laintiffs’ project. Based on these facts, and in accordance with the principle established in Aucoin, supra, it is my view the Minister should have allowed the deductions for expenses and capital cost allowance claimed by the plaintiffs in their 1984 taxation year.
For these reasons, the plaintiffs’ appeal is allowed with costs.
Appeal allowed.