Polonovski v. Agence du revenu du Québec, 2020 QCCQ 8943

The two taxpayers acquired a rental property (the “Garnier” property), consisting of a duplex and triplex, in 2004. In 2009, they decided to enlarge the duplex and convert it to an open-plan “cottage.” After receiving the required approval from the City of Montreal, in April, 2010, a declaration of co-ownership was registered, permitting the effective severance (pursuant to a co-ownership, or “indivision,” agreement) of the future cottage and the triplex. In November 2010, the cottage was listed for sale, and sold in 2011.

A second rental property (the “Mentana” property, consisting of two duplexes) was acquired in March 2010, in June 2010 the City of Montreal approved the horizontal severance of the two duplexes pursuant to an indivision agreement and in December 2011, the indivision agreement took effect and one of the duplexes was sold subject to that agreement.

The “Roy/Mentana” property, consisting of various units was acquired in 2010 and effectively partitioned in 2011 through indivision agreements, with the result that one of the Mentana duplexes was separately sold in 2011 at a gain, and four of the Roy/Mentana units were separately sold in 2011.

A third rental property (the “Roy/Mentana” property, consisting of various units) was acquired in April, 2010 and effectively through an indivision arrangement four units were severed and then sold in April, May, June and November 2012.

Quenneville JCQ confirmed the ARQ assessments of the gains on the Mentana and Roy/Mentana sales as being inventory gains in light inter alia of the business acumen of the taxpayers, the number of transactions (including some not described above) occurring over a short period, and the significant sums spent on renovating the units. She also found that in light of these circumstances, and in contrast to Latulippe, the application for division of the Garnier property (which was made around the time of the acquisition of the other two properties) evinced a conversion of the Garnier property from capital property to inventory, stating (at para. 196, TaxInterpretations translation):

From the date of conversion of the Garnier Building and upon purchase of the Mentana and Roy/Mentana Buildings, there was a clear intention to convert the capital assets to inventory.

In assessing the gain on the Garnier duplex, the ARQ had applied the methodology in IT-218R, para. 15, which was to calculate a notional capital gain at the time of seeking approval from the City for the indivision, based on the estimated FMV of the duplex at that time, and treating the excess of the gain in 2011 over that capital gain as being a business property. However, consistently with IT-218R, the resulting taxable capital gain was not recognized until the year of the actual sale in 2011. In the course of rejecting the taxpayers’ submission that the CAE decision should instead be applied to treat the taxable capital gain as only being includible in the taxpayers’ income in 2010, Quenneville JCQ stated (at paras. 206-207, 210):

[T]hat case … dealt with the change of use of property considered to be inventory that had been transferred in the course of a refinancing, but which had continued to be used by the plaintiff for the same purposes as before the transfer.

That decision must therefore be distinguished from the present case, since here there was no change in the use of the building. The plaintiffs' intention was to acquire and hold the building in order to earn rental income and then to generate a profit at the time of sale. In both cases, the income is derived from the building … .

It can be seen that this argument is attractive to the plaintiffs, allowing them to argue that the capital gain should have been taxed in 2010 and to argue that this is a statute-barred year. However, in all other cases, mainly where the sale of the property occurs years later, the taxpayer would be at a distinct disadvantage in the scenario proposed by the plaintiffs.

Two individuals acquired a rental property, consisting of a duplex and triplex, in 2004. In 2009, they decided to enlarge the duplex and convert it to an open-plan single-unit dwelling. After receiving the required approval from the City of Montreal in April, 2010, a declaration of co-ownership was registered, permitting the effective severance (pursuant to a co-ownership, or “indivision,” agreement) of the triplex and the former duplex, which was sold the next year following its renovation.

Quenneville JCQ found that, in light of the taxpayers’ other increased real estate activity at the around the same time, and in contrast to Latulippe, the application for division of the property evinced a conversion of the property from capital property to inventory.

In assessing the gain on the renovated unit, the ARQ had applied the methodology in IT-218R, para. 15, which was to calculate a notional capital gain at the time of seeking approval from the City for the division, based on the estimated FMV of the duplex at that time, and treating the excess of the gain in 2011 over that capital gain as being a business property. However, consistently with IT-218R, the resulting taxable capital gain was not recognized until the year of the actual sale in 2011. In the course of rejecting the taxpayers’ submission that the CAE decision should instead be applied to treat the taxable capital gain as only being includible in the taxpayers’ income in 2010, Quenneville JCQ stated (at paras. 206-207, 210, TaxInterpretations translation):

It can be seen that this argument is attractive to the plaintiffs, allowing them to argue that the capital gain should have been taxed in 2010 and to argue that this is a statute-barred year. However, in all other cases, mainly where the sale of the property occurs years later, the taxpayer would be at a distinct disadvantage in the scenario proposed by the plaintiffs.