Date: 20010803
Docket: 2000-3791-IT-I
BETWEEN:
FRANK DELUCA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1]
These appeals are from assessments for the appellant's 1993
and 1994 taxation years. They involve the deduction of losses
incurred by the appellant in those years from an investment that
the appellant made in three condominium units in London,
Ontario.
[2]
The appellant is and, during the period was, a high school
mathematics teacher.[1] In 1988 he and his spouse purchased three condominium
townhouse units at 470 Second Street, London, Ontario. The
units were part of a complex of 45 units promoted by a
Mr. Wells among the high school teachers who were colleagues
of the appellant. The units cost $72,300 each for a total of
$216,900. The appellant put $2,000 of his own money into the
purchase price of each unit. The remainder of the purchase price
was provided by a 75% mortgage of about $54,000 and the rest
through a line of credit with a trust company that had been
arranged by the promoter Mr. Wells.
[3]
The appellant believed the investment was a good one. He was
influenced to some degree by the fact that his colleagues were
investing in the project. Some of them taught business and others
had had favourable experience in investing in real estate. He was
given a projection of the cash flow by Mr. Wells that showed
a projected positive cash flow in year six and a profit in
year four. With the benefit of hindsight the projections
seem unrealistic. I have no basis for believing that they were
unrealistic in 1988.
[4]
The appellant was also influenced by the fact that real estate
prices were rising in the late 1980s. There was some argument by
Mr. Deluca's representative that the appellant's
intention was to realize a capital gain. One might reasonably
consider that buying with a view of reselling and realizing a
capital gain is an oxymoron, in that such a purpose, if it is a
real motivating factor, would turn the project into an adventure
in the nature of trade. However, I tend to be somewhat sceptical
of belated assertions that the object was to flip the property at
a profit. As was said in Donyina v. The Queen, file
2001-934(IT)I at page 10:
10.
If what is ostensibly a rental property was acquired and held in
the course of an adventure in the nature of trade and it was
reasonable to expect a profit on the resale the losses
(i.e. carrying costs net of rentals received) should not
be disallowed on the basis of REOP (Roopchan). The court
should however examine with some care an ex post facto
declaration that property that was carried for some years at a
loss is part of a speculative venture in which the motive was
resale at a profit. This is not something that one would expect
someone readily to admit if the property were sold at a
profit.
[5]
That was, in any event, not the basis on which the case was
argued.
[6]
In the late 1980s or early 1990s the builder went bankrupt and
the participants in the project were unexpectedly saddled with
large obligations before the project could be registered. The
builder owed substantial sums of money to the original owner and
they had to pay these off. They had to build a bern (a form of
embankment) and a high fence along the railway line that ran
behind the properties. Sewer charges and taxes were left unpaid
by the builder and had to be paid. The result was that the
appellant as well as the other participants had to obtain
additional financing through their line of credit. The appellant
had to put an additional mortgage on his home. The units were
rented as early as 1988 but the rent was seized by the
builder's creditors. The units were not registered in the
appellant's name until 1991.
[7]
The rather rosy cash flow projections made by Mr. Wells did
not materialize. The reality was somewhat more sombre:
Gross
Net
Rental
Rental
Year
Income
Loss
1988
$16,335
1989
$14,070
1990
$32,677
1991
$16,368 $21,261
1992
$19,113 $37,188
1993
$28,125 $23,931
1994
$23,812 $30,258
1995
$20,012 $11,929
1996
$12,973 $16,273
1997 $
9,612 $ 5,011
1998 $
9,612 $ 3,022
1999 $
9,612 $ 2,279
[8]
In August of 1993 the appellant took over the management of the
three units in an attempt to improve the return. This involved
essentially two changes. Prior to that time the rents from all
the units were pooled and the participants received a share based
on the number of units they owned, regardless of whether their
particular units were rented. After August the appellant assumed
the responsibility of finding and dealing with the tenants and of
doing the maintenance and repairs himself. Previously the cost of
repairs had been pooled. Also, the appellant had to evict some
tenants who had been allowed to go for a long period without
paying rent. In 1994 as well he had to do extensive repairs to
the unit where the tenants whom he had evicted had lived.
[9]
In 1994 he sold one unit and later he sold another. At present he
owns one unit and has raised the rent from $800 per month to $900
per month. Evidently this unit is turning a profit although he is
still struggling with the debt load from the earlier
refinancing.
[10] The
detailed computation for 1993 and 1994 is as follows.
1993
1994
Gross Income
$28,125.00
$23,812.00
Expenses
Advertising
$
15.00
$ 52.95
Insurance
69.00 326.90
Interest
33,078.00
28,573.80
Maintenance & repairs
1,546.00 7,316.80
Management & administration
fees
3,135.00
Motor vehicle
expenses
312.34
Office 198.00
182.90
Legal, accounting & other
professional fees 455.00
4,810.52
Property taxes
7,210.00 5,913.69
Salaries, wages &
benefits
1,200.00
Travel
1,084.74
Utilities 315.00 878.42
Telephone
222.47
Bank
charges
59.55
Other expenses* 9,170.00____________
Total Expenses
$52,056.00
$54,070.08
Net
Loss**
$23,931.00
$30,258.08
*
details of other expenses were not provided
**
100% of reported loss claimed by Appellant
[11] The
Minister disallowed the losses and in support of his doing so now
intones the ritual incantation "no reasonable expectation of
profit".
[12] One of
the most significant assumptions pleaded is that the disallowed
rental expenses were
"personal or living expenses of the Appellant"
This expression is defined in section 248 of the
Income Tax Act in part as follows.
"personal or living expenses" includes
(a)
the expenses of properties maintained by any person for the use
or benefit of the taxpayer or any person connected with the
taxpayer by blood relationship, marriage or adoption, and not
maintained in connection with a business carried on for profit or
with a reasonable expectation of profit.
[13] This
point was not pursued in argument and was not mentioned in
part C of the reply as one of the grounds relied on and in
any event the notion that the expenses were personal or living
expenses was thoroughly demolished. Neither the appellant nor any
related person lived in the units.
[14] In
determining whether the losses are deductible it requires
something more than mechanically examining the losses, deciding
that the interest and other expenses exceed the revenue and
chanting the inevitable mantra REOP. This case is a very good
example of REOP being used as a substitute for analysis, a
practice that was criticized in Costello v. The Queen,
98 DTC 1362. Although the assessor's analysis was
not put in evidence it seems that some examination was done but
it was evidently not used as a basis of the assessment. One needs
only to look at the expenses claimed to see that some of them cry
out to be questioned. For example $7,316.80 for maintenance and
repairs seems high and although counsel suggested in
cross-examination of the appellant that only about one half of
the amounts were supported by receipts, no evidence of this was
put forward and the question of the quantum of the expenses or
their authenticity was not raised in the pleadings. Similarly
$1,084 for travel strikes me as somewhat odd, given the nature of
the investment. Salaries of $1,200 were allegedly paid to the
appellant's son for help in cleaning up one of the units from
which the tenants had been evicted. This amount - a round
figure - needed to be questioned.
[15] The only
amount that is so patently wrong that it would be an error to
allow it is the $4,810 that the appellant claimed for legal,
accounting and professional fees. He admitted that this amount
was substantially all for legal fees incurred in selling one of
the units in 1994. Clearly such an expense cannot be deducted as
a current expense of the rental operation. His representative
suggested that part of it might be deductible in computing a
terminal loss on the sale of the unit. That may be but no
terminal loss was pleaded, claimed or proved.
[16] I come
back to the question: did the appellant have a business? In my
view he did and it is reasonable that he be allowed the losses,
except for the $4,810.52 incurred in selling one of the
condominium units. If REOP is relevant, and evidently it is, it
is clear that his expectation of profit was reasonable. By the
year 2000 he was it seems realizing a profit on the remaining
unit. Had he kept the other two units it seems probable that
"in the fullness of time" — to use the phrase
used in Allen & Milewski v. The Queen,
99 DTC 968, aff'd 2000 DTC 6559 —
he would have realized a profit as well.
[17] I think
there has been a tendency to use the REOP principle excessively.
The tax authorities appear to have learned nothing from the cases
that I referred to in paragraphs eight and nine of
Donyina and they seem to be applying it indiscriminately
against a large number of businesses and investments just because
the taxpayer's expectations have not been met. The present
case is a good example. The taxpayer embarked on a business
venture that for reasons beyond his control did not generate
profits the way he reasonably hoped it would. Unexpectedly events
over which Mr. Deluca had no control required that more
capital be put into the project and he did so by putting a
mortgage on his house. He made every effort to improve the
situation by getting out of the rental pool and taking over the
administration. Finally he decided to cut his losses by selling
two of the three units. The CCRA, waving the REOP banner, and,
against all the evidence and against all reason, disallowed the
losses on the theory that the expenses were personal or living
expenses.
[18] The
appeals are allowed and the assessments are referred back to the
Minister of National Revenue for reconsideration and reassessment
to allow the deduction of losses of $23,931 and $25,447.56 in
1993 and 1994 respectively.
[19] The
appellant is entitled to his costs, if any, in accordance with
the tariff.
Signed at Ottawa, Canada, this 3rd day of August 2001.
"D.G.H. Bowman"
A.C.J.
COURT FILE
NO.:
2000-3791(IT)I
STYLE OF
CAUSE:
Between Frank Deluca and
Her Majesty The Queen
PLACE OF
HEARING:
London, Ontario
DATE OF
HEARING:
July 25, 2001
REASONS FOR JUDGMENT
BY:
The Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF
JUDGMENT:
August 3, 2001
APPEARANCES:
Agent for the
Appellant:
Bernard Linseman, C.A.
Counsel for the
Respondent:
J. Michelle Farrell
COUNSEL OF RECORD:
For the
Appellant:
Name:
--
Firm:
--
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3791(IT)I
BETWEEN:
FRANK DELUCA,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on July 25, 2001, at London,
Ontario, by
The Honourable D.G.H. Bowman
Associate Chief Judge
Appearances
Agent for the
Appellant:
Bernard Linseman, C.A.
Counsel for the Respondent: J.
Michelle Farrell
JUDGMENT
It is
ordered that the appeals from assessments made under the
Income Tax Act for the 1993 and 1994 taxation years be
allowed and the assessments be referred back to the Minister of
National Revenue for reconsideration and reassessment to allow
the deduction of losses of $23,931 and $25,447.56
respectively.
The
appellant is entitled to his costs, if any, in accordance with
the tariff.
Signed at Ottawa, Canada, this 3rd day of August 2001.
A.C.J.
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