Date: 20020131
Docket: 2000-2433-IT-I
BETWEEN:
DOUGLAS L. TITUS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the
Appellant:
The Appellant himself
Counsel for the
Respondent:
Catherine Letellier De St-Just
Reasons for Judgment
(delivered orally from the Bench on
November 23, 2001 at Toronto, Ontario)
GARON, C.J.T.C.C.
[1] These are appeals from the
reassessments of income tax for the 1994, 1995 and 1996 taxation
years.
[2] By these reassessments the
Minister of National Revenue disallowed rental losses in the
amounts of $9,867.00, $10,367.00 and $7,984.00 for the 1994, 1995
and 1996 taxation years respectively in respect of a property
located at Kirkfield, Ontario.
[3] The Appellant and a chartered
accountant by the name of Mr. Philip Graham Dunn testified at the
hearing of these appeals. The Respondent did not call any
witness.
[4] The assumptions of fact in support
of these reassessments are found in paragraph 5 of the Reply to
the Notice of Appeal, which reads as follows:
(a) the Appellant purchased a seasonal recreation
property: a cabin plus guest house (bunkie) located at R.R.#3,
Kirkfield, Ontario (the "purported rental property") in
August 1991 for $87,500;
(b) the Appellant financed the purchase with a $65,500
mortgage, which was renegotiated in October 1992 for a new amount
of $85,500 with terms of interest only payments. Additional
financing through a line of credit was arranged in August 1994
and December 1995 and the Appellant claimed 50% of the interest
payments on the line of credit as rental expenses in 1995 and
1996 and 100% in 1994;
(c) in computing income for the 1994, 1995 and 1996
taxation years, the Appellant deducted rental losses with respect
to the purported rental property;
(d) the rental income, expenses and losses, as reported
by the Appellant in the respective taxation years are as
follows:
1994
1995
1996
Gross
Rent
$1,100
$1,500
$1,500
Expenses (rounded)
Property
Tax
896
841
833
Mortgage
Interest
8,537
8,274
8,277
Insurance
528
528
504
Utilities
273
279
415
Maintenance & Repair
390
471
367
Motor Vehicle Expenses 770
690
Office
Expenses
24
16
Other
234
1,085
142
Legal,
Accounting
534
1,002
______________________________
Total
Expenses
$12,186 $13,186
$10,538
Less: Personal, 10%
(1,219)
(1,319)
(1,054)
Rental Loss Claimed
$9,867
$10,367
$7,984
(e) the Appellant also reported rental losses from
the property in prior years as follows:
1991
1992
1993
Gross
Rent
Nil
Nil
$1,000
Rental Loss Claimed
$3,213
$9,391
$8,347
(f) the appellant never made a reasonable effort
to advertise or market the property to produce rental
income;
(g) in the 1994, 1995 and 1996 taxation years, the rent
charged was insufficient to cover the mortgage interest expense
incurred;
(h) the Appellant had no reasonable expectation of
profit from the alleged rental activity during 1994, 1995 and
1996;
(i) the rental expenses claimed were not made or
incurred for the purpose of gaining or producing income from a
business or property;
(j) the disallowed expenses were personal or living
expenses of the Appellant.
[5] On behalf of the Appellant,
subparagraphs (a), (b), (c), (d) and (g) of paragraph 5 of the
Reply to the Notice of Appeal were admitted. Subparagraph (e) was
admitted by the Appellant after the Respondent recognized that
the Appellant had received rent in the amounts of $400.00 and
$1,200.00 for the 1991 and 1992 taxation years respectively. The
other subparagraphs of paragraph 5 of the said reply were
denied by the Appellant.
[6] In his testimony, the Appellant,
who was called to the Bar in 1977, mentioned that the
recreational property was situated right on the lake, called
Canal Lake, and is approximately sixty or seventy miles from
downtown Toronto; it is not much more than one-hour drive
from Toronto.
[7] The total area of the cabin is not
more than 900 square feet. The building or cabin on the property
was old. In the rental questionnaire dated June 4, 1999, the
Appellant stated that the age of the property was approximately
45 years old. The cottage was winterized. There was also a
guesthouse on the lot. According to the Appellant, there were
nice trees on the lot, which had an area of between half an acre
to three-quarters of an acre. The attractiveness of this lot is
that it has 120 feet of shoreline. The lake fronting the property
was part of the Trent Canal waterway system. It is not far from
Lake Simcoe.
[8] The immediate portion of the lake
bordering on the property has a sandy bottom and is shallow over
a significant area. This environment was "great for the
kids", to adopt the Appellant's phrase.
[9] The Appellant mentioned that he
was familiar with the area since he frequented it from the time
he was very young, his parents having had a cottage on this lake
for a number of years. The proximity of his parents' cottage
was a factor, according to his deposition, when he decided to
purchase the subject property situated on the same lake.
[10] The Appellant testified that he thought
at the time of the purchase of the property that he could rent
out this property and earn income from it. He believed that he
could get from $800.00 to $1,500.00 of rent "every one to
two weeks". He also believed that the property could even be
rented during the winter because access by car was possible
during that season.
[11] The Appellant determined the rental
value of the property by relying on advertisements in newspapers
where rentals for cottages were listed. He did not however visit
the properties referred to in the newspapers. The Appellant
decided not to advertise in the newspapers on account, at least
in part, of his financial situation. The Appellant was of the
view that advertising by word of mouth through friends would be
sufficient in the circumstances. However, his efforts at renting
this property were not successful.
[12] His gross revenue from rentals amounted
to only $400.00 in 1991 for a four-month period, $1,200.00 in
1992, $1,000.00 in 1993, $1,100.00 in 1994 and $1,500.00 in 1995
and 1996. He attributed this low gross revenue from rentals to
the fact that the cabin lacked many amenities. Reference was also
made to the economic situation prevailing at the time.
[13] The Appellant has also testified that
substantial improvements and repairs were carried out on this
property. According to paragraph numbered 8 of the rental
questionnaire dated June 4, 1999, some of the work was done in
1994, 1995 and 1996. The work related to the outhouse, the well,
the septic system, the roof and the TV antenna.
[14] At the time of the hearing of these
appeals, the Appellant still owned the subject property. He
indicated that at one point, he thought about selling this
property but decided against this course of action.
[15] I turn now to the evidence relative to
the financial aspects of this case, with respect more
particularly the purchase of this property, its financing and
improvements relating thereto, as well as the Appellant's
financial circumstances.
[16] As appears from subparagraph 5(a) of
the Reply to the Notice of Appeal, the subject property was
purchased for $87,500.00, which the Appellant considered at the
time to be an attractive price. The acquisition of the property
was financed by a mortgage loan of $65,500.00 obtained through a
mortgage broker with terms of interest-only payments.
According to the rental questionnaire referred to earlier, the
rate of interest was 12.5%. It was an open mortgage initially for
a one-year term. The Appellant stated that he could not get
financing from a bank. The mortgage loan was renegotiated in
October of 1992 and the loan was increased to $85,500.00, as
mentioned in subparagraph 5(b) of the Reply to the Notice of
Appeal.
[17] At the time of the purchase of the
property in issue the Appellant had just been employed as a
lawyer at a salary of $65,000.00 per year. Immediately prior to
August 1991, the Appellant had been unemployed for some time. In
his new position he obtained no increase in salary until he was
laid off in July 1994.
[18] The Appellant's income tax returns
for 1994, 1995 and 1996 were filed with the Court. The tax return
for 1994 shows that a) the Appellant had employment income in the
amount of $49,769.59, b) he received unemployment insurance
benefits in that year totalling $3,861.00 and c) net professional
income in the amount of $1,870.00. For the year 1995 the tax
return indicates that the Appellant had employment income of
$37,804.00, received unemployment insurance benefits totalling
$9,886.00 and net professional income of $1,648.00. For the 1996
taxation year, according to the tax return for that year, the
Appellant had no employment income and received unemployment
benefits of $6,720.00 and net professional income of
$7,641.66.
[19] The document entitled "Projected
Income & Expenses - Rental Property - June/July
1991" was filed with the Court. The Appellant testified that
the foregoing financial statement had been prepared in 1999 at
the request of the Canada Customs and Revenue Agency. The
information contained in this document was based on his notes
made a month or two prior to the purchase of the property and his
recollection of his estimate of the projected income and expenses
that he had in mind at the time. The relevant portion of the
"Projected Income & Expenses - Rental Property
- June/July 1991" is reproduced below:
INCOME
Rental Income
52 weeks @
$400/week
$20,800
EXPENSES
Advertising
500
Property Taxes
750
Maintenance &
Repairs
600
Insurance
250
Utilities
800
Beach
Fees
75
Mortgage
Interest
5,200
8,175
Less: Personal Use -
10%
818
7,358
_________
$ 13,443
_________
(Footnote omitted).
[20] In his evidence concerning the
projected income and expenses referred to earlier, the Appellant
stated that he planned to utilize the subject property for
himself for about five weeks per year. This explains the notation
towards the bottom of the statement where it is written
"Less: Personal Use - 10%".
[21] The evidence of Mr. Dunn covers a few
specific areas and does not add anything of significance to the
Appellant's version of the facts.
Analysis
[22] The question in issue is whether the
Appellant had a reasonable expectation of profit from the rental
activity involving the subject property in the 1994, 1995 and
1996 taxation years.
[23] In considering this question the first
matter that should be looked at is the financing of the
acquisition of the property. Right from the beginning, almost 75%
of the purchase price of this property was financed at a high
rate of interest of 12.5%. Fourteen months later, that is in
October 1992, refinancing occurred (probably by reason of the
fact that substantial work and improvements had to be carried out
on this property) and the amount of the loan was increased to
$85,500.00, an amount almost equal to the purchase price of the
property, which was $87,500.00 as noted earlier. There were other
financing arrangements made in August 1994 and December 1995, the
details of which were not provided at the hearing of these
appeals.
[24] The mortgage interest expense in all
the three years in issue was slightly in excess of $8,000.00 per
year. This heavy financing burden must be viewed in relation to
the amount of gross rentals generated by this property. For 1994
the amount of rental was $1,100.00, and $1,500.00 for each of the
years 1995 and 1996. The interest payments on the mortgage alone
exceeded in each of the years in issue the gross rental revenue
by about five times after taking into account the 10% reduction
of the expenses relating to the personal use of the property. If
the other expenses are taken into account in each of these years,
the expenses exceeded the gross revenue by a much greater
margin.
[25] There is a further fact that in
evaluating the totality of the evidence I find that the personal
factors played a role in the Appellant's acquisition of this
property. The Appellant admitted candidly that the fact that his
parents owned a cottage on the same lake enticed him to purchase
the subject property. He was also familiar with the area as he
had been going to his parents' cottage for a great number of
years. In addition, he himself was interested in spending his
holidays at this cottage. The property was a vacation site.
[26] In considering the overall evidence in
this case, I am also influenced by the fact that the Appellant
did not appear to have made serious efforts with a view to
renting this property. He did not advertise the property in the
newspapers, which is a well-recognized method to attract
potential customers. He gave certain explanations in this regard
but I have not been persuaded by them. In any event, the
Appellant has not disproved the assumption in subparagraph 5(f)
of the Reply to the Notice of Appeal respecting the advertisement
of the rental property.
[27] Among other considerations, the
Appellant referred to external circumstances over which he had no
control. The substance of this statement must be put into
perspective. For instance, the loss of his employment in 1994
does not explain the lack of advertising in prior years. Also, at
the time of the purchase of this property the Appellant was aware
of his own financial situation and the constraints within which
he had to operate.
[28] Regarding the chart showing the
projected income and expenses, I have no difficulty in concluding
that the projection of gross revenue and the interest expense
relating to the mortgage were totally unrealistic. These
projections are totally at variance with the economic financial
reality prevailing at the time. Also, in establishing the
projected total rental income, the Appellant stated that he
relied on information provided by the newspapers, as mentioned
earlier. However, he did not visit comparable properties, which
were advertised for renting. I have difficulty understanding that
it would have been costly for him to visit a few similar
properties in the adjoining area with a view to having a general
idea of the rental market for cottages.
[29] In view of the above, I have come to
the conclusion that the Appellant did not have a reasonable
expectation of profit from the rental operation involving the
subject property in the years 1994, 1995 and 1996. Therefore, the
Appellant is not entitled to deduction of the rental losses in
each of the three years in issue.
[30] For these reasons, the appeals from the
reassessments for the taxation years 1994, 1995 and 1996 are
dismissed.
Signed at Ottawa, Canada, this 31st day of January 2002.
C.J.T.C.C.
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