Gagné v. The Queen, docket 2000-3399-IT-I (Informal Procedure)

Date: 20010830

Docket: 2000-3399-IT-I

BETWEEN:

RICHARD GAGNÉ,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Tardif, J.T.C.C.

[1]      This is an appeal concerning the 1996 and 1997 taxation years.

[2]      The issue is whether the expenses claimed each year on a condominium in Burnaby were incurred by the appellant during the taxation years at issue for the purpose of gaining or producing income from a property or business.

[3]      In making the assessments at issue in this appeal, the respondent relied on or assumed the following facts:

[TRANSLATION]

(a)         the appellant purchased a condominium at 2060 Bellwood Avenue in Burnaby, British Columbia;

(b)         the condominium had two bedrooms, a living room, a kitchen and a bathroom; household appliances such as the stove, refrigerator and dishwasher were included;

(c)         the condominium was in a 100-unit high-rise apartment building (Vantage Point);

(d)         the appellant purchased the condominium - a Type F unit, number 1105 - for $167,990 on December 27, 1989;

(e)         the condominium was financed as follows:

            (i)         cash                                                          $1,500

            (ii)         mortgage                                               $117,593

            (iii)        promissory note                                        $48,897

                                                                                    $167,990;

(f)          the financing initially represented 99 percent of the total cost;

(g)         the unit was part of a pooling of condominiums the management of which was initially entrusted to the North America Land Corporation and then transferred to Gestion Profissimo in 1995;

(h)         the management of the appellant's condominium always generated losses:

            (i)          1989                                         $2,112

          (ii)         1990                                         $20,397

            (iii)        1991                                         $18,521

            (iv)        1992                                         $18,222

            (v)         1993                                         $19,603

            (vi)        1994                                         $16,402

            (vii)       1995                                         $8,958

            (viii)       1996                                         $6,567

            (ix)        1997                                         $3,044;

(i)          among other things, for the years at issue, the losses claimed on the condominium must be increased by $3,094 and $3,294, respectively, since the interest on the promissory note was claimed on line 221 of the income tax return (expenses to earn investment income);

(j)          the appellant always claimed rental losses and never claimed any depreciation expense;

(k)         the rental income from the condominium, which corresponded roughly to the market price, was as follows:

            (i)          1989                                         nil

          (ii)         1990                                         $9,360

            (iii)        1991                                         $9,828

            (iv)        1992                                         $9,481

            (v)         1993                                         $9,391

            (vi)        1994                                         $9,181

            (vii)       1995                                         $8,577

            (viii)       1996                                         $9,534

            (ix)        1997                                         $9,512;

(l)          each year, the interest expense (see the following table) alone exceeded the gross rental income, which was stable from year to year:

            (i)          1990                                         $20,538

          (ii)         1991                                         $18,946

            (iii)        1992                                         $17,600

            (iv)        1993                                         $16,163

            (v)         1994                                         $19,040

            (vi)        1995                                         $13,526

            (vii)       1996                                         $12,589

            (viii)       1997                                         $10,589;

(m)        the appellant did nothing to reduce the amount of his loans during the years at issue;

(n)         the appellant had no reasonable expectation of profit from the Burnaby condominium during the 1996 and 1997 taxation years;

(o)         the rental expenses claimed each year on the Burnaby condominium were personal or living expenses of the appellant and were not incurred by him for the purpose of gaining or producing income.

[4]      After being sworn, the appellant admitted the facts alleged in subparagraphs 8(a) to (l) but denied the content of subparagraphs (m) to (o).

[5]      The appellant testified that he had acquired investment experience and expertise over the years both on the stock market and in real estate. He explained how he acquired his practical and theoretical experience; he said that he had also taken investment courses. Through his studies and experience he discovered leverage, which consists in taking advantage of the borrowing power conferred by immovable property that has increased in value, making it possible to obtain fresh money to invest in other projects.

[6]      The appellant described his various experiences and the investments that led him to purchase the condominium in Burnaby, British Columbia, for $167,990 in December 1989. He filed documentary evidence concerning financing, projections and planning.

[7]      He also described how he went about ensuring proper control and follow-up with regard to the factors that might have financial consequences. Thus, although he never went to Vancouver, he took the management of his condominium out of the hands of the North America Land Corporation and entrusted it to an individual in whom he had complete confidence, which enabled him to exercise better control and also to reduce expenses.

[8]      He explained as well that he instructed someone who was going to Vancouver to obtain both a report on the condition of the premises and an overall assessment. The appellant wanted to know whether everything was consistent with the various descriptions he had been given, since he had never visited the condominium he purchased.

Analysis

[9]      There is no doubt that the evidence shows that the appellant had a very keen interest and wanted very much to make a profit. However, the evidence in no way indicates that the profit he expected or hoped for was to come from renting the condominium.

[10]     The weight of the evidence shows instead that the appellant basically wanted to make a profit on the eventual sale of his condominium. The evidence demonstrates that he was actually much less concerned about the operating deficits and much more aware of the development of the real estate market in Vancouver and area.

[11]     Moreover, the appellant admitted, simply and with a sincerity that does him credit, that his primary goal was to make a profit on the eventual sale of the condominium. His rather speculative expectations and hopes explain how rental viability could be secondary, since it was not the primary objective.

[12]     He certainly made considerable and commendable efforts to reduce expenses, since for all practical purposes he had no control over income. When he became aware of the risk of major losses of income because of potential dishonesty on the part of the manager, he quickly disposed of the property.

[13]     The distance between the location of the condominium and the appellant's home, his experience in the real estate market and his financial constraints are factors that are all indicative of a more speculative project rather than of a goal of renting the property purchased. The huge distance between the appellant and the place where the condominium was located is a very negative factor from the perspective of rental-based profitability.

[14]     This reality explains and also justifies the contradiction between the fact that the property was financed and the reasonable expectation of profit. It is difficult, not to say impossible, to expect to make a profit from a project that is 100-percent financed, especially when the property or business was purchased at market price.

[15]     It is possible to hope for viability with 100-percent financing if the purchase price is below the market cost and income is comparable to market income. In this case, the interest expenses alone fluctuated between 219 percent and about 125 percent of the income during the eight years following the purchase. It is common knowledge that operating expenses are not limited only to interest expenses; many other expenses must be added and charged against income before it can be concluded that there is a profit.

[16]     On this subject, in Mohammad v. The Queen, [1998] 1 F.C. 165, 97 DTC 5503, Robertson J.A. of the Federal Court of Appeal provided clarification that is of greater relevance; it is appropriate to reproduce the following extract from that judgment:

            . . . Taxpayers intent on financing the purchase of a rental property to the extent that there can be no profit, notwithstanding full realization of anticipated rental revenue, should not expect favourable tax treatment in the absence of convincing objective evidence of their intention and financial ability to pay down a meaningful portion of the purchase-money indebtedness within a few years of the property's acquisition. If because of the level of financing a property is unable to generate sufficient profits which can be applied against the outstanding indebtedness, then the taxpayer must look to other sources of income in order to do so. If a taxpayer's other sources of income, e.g. employment income, are insufficient to permit him or her to pay down purchase-money obligations then the taxpayer may well have to bear the full cost of the rental loss. Certainly, vague expectations that an infusion of cash was expected from Aunt Beatrice or Uncle Bernie will not satisfy the taxpayer's burden of proof. In practice, the taxpayer will discharge that burden by showing that significant payments were in fact made against the principal indebtedness in the taxation years closely following the year of purchase.

. . .

[17]     Even if the significant carrying charges payable over a five-year period were disregarded, the interest payable and paid by the appellant during the years at issue was so high compared with gross income that it absolutely precluded any profit being made during those years. In fact, the obligation to pay other expenses such as property taxes, condo fees and insurance, which were certainly substantial, cannot be ignored.

[18]     In light of the evidence adduced, it seems to me-given the basically mathematical constraints involved-that the appellant could not expect to make a profit in the 1996 and 1997 taxation years. Indeed, the evidence shows that he received the highest possible income and, in spite of that, he incurred a loss, most of which resulted from the interest that was payable because he had made the purchase without laying out anything at all.

[19]     I therefore conclude, on the evidence adduced, that the appellant could not expect to make any profit in the years at issue. Accordingly, the appeal must be dismissed.

Signed at Ottawa, Canada, this 30th day of August 2001.

"Alain Tardif"

J.T.C.C.

Translation certified true

on this 30th day of May 2002.

Erich Klein, Revisor

[OFFICIAL ENGLISH TRANSLATION]

2000-3399(IT)I

BETWEEN:

RICHARD GAGNÉ,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on July 16, 2001, at Québec, Quebec, by

the Honourable Judge Alain Tardif

Appearances

For the Appellant:                      The Appellant himself

Counsel for the Respondent:      Stéphanie Côté

JUDGMENT

          The appeal from the assessments made under the Income Tax Act for the 1996 and 1997 taxation years is dismissed in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 30th day of August 2001.

"Alain Tardif"

J.T.C.C.

Translation certified true

on this 30th day of May 2002.

Erich Klein, Revisor

[OFFICIAL ENGLISH TRANSLATION]