Paul Aucoin v. Minister of National Revenue, [1991] 1 CTC 2191, 91 DTC 313

Garon, T.C.J.:— In this case, the appellant appeals income tax reassessments for the 1984, 1985 and 1986 taxation years. By his reassessments for these three years, the Minister of National Revenue disallowed the deductions of rental losses claimed by the appellant in the amounts of $3,225.72 for the 1984 taxation year, $4,125.80 for the 1985 taxation year and $3,038 for the 1986 taxation year.

In 1978, the appellant was transferred from Canada to Antigua by his employer, the Bank of Nova Scotia. He had been working in the Antilles for a few years when he decided to purchase in 1982 a condominium in Miami, Florida, for $67,500 (U.S.). This property is located in a nice residential district. There is evidence that the appellant was familiar at that time with the investment climate in that region.

The acquisition of the property was financed through a first 30-year mortgage in the amount of $50,000 (U.S.) bearing interest at the rate of 13 per cent and the balance from savings that he had accumulated. Part of such savings came mainly from certificates of deposits worth $10,000 which were generating good interest at the time and the balance in the amount of $14,000 originated "from a relocation allowance provided by the bank" for the bank’s employees serving abroad. The appellant said that he "chose to put all his savings in that building”.

It is common ground that the appellant purchased that property for the purpose of earning rental income. In this connection, it was mentioned in a letter dated January 14, 1988 to the Department of National Revenue by the appellant's accountant in support of the contention that the above property was purchased with the intention to earn income that" it was expected that the income would increase at the rate off] inflation and the mortgage payment would remain constant producing a substantially larger income".

The appellant rented the condominium for $750 (U.S.) per month from September 1982 to August 1983 to a company related to the seller. Net income was derived from that property in 1982 and in 1983 while he was a U.S. resident; the exact amount could not be determined. The appellant contracted with a real estate firm to rent and manage the subject property.

Owing to a sharp decline in property values at that time throughout Florida, the appellant was forced to reduce his monthly rent to $525 (U.S) in the fall of 1983. The value of theproperty fell to $55,000 (U.S.).

Late in 1983, the appellant attempted without success for many months to sell his condominium and finally decided to withdraw it from the market because of poor real estate market conditions. Further steps were taken later on with a view to selling the property. For instance, the property was listed late in 1985 or early 1986 for sale by a real estate firm by the name of Peninsula Real Estate Inc. in a magazine “Real Estate Market". In addition, the appellant admitted that he had been in touch on a regular basis with the same real estate company and the latter firm was aware that he was interested in selling.

In June 1984 the appellant returned to Canada and has been residing in New Brunswick ever since. During that year, he ceased being employed by the bank.

Neither the appellant nor his family have at any time occupied this property. It was never used as a vacation property. The appellant has never been involved in real estate transactions save in those pertaining to his personal residence.

Statements of real estate rentals were filed by the appellant for the years 1984, 1985 and 1986 as part of his income tax returns for these years and the following is shown:

For the years 1987, 1988 and 1989 the appellant reported the following losses from the rental of the above property:

In August 1990 the monthly rental was $650 and has been at that level since December 1988 and it would appear that another loss would be sustained for 1990 in the vicinity of $3,000. It is to be noted that no deduction of capital cost allowances had been taken into account in the above calculations.

No firm view has been expressed by the appellant as to the time at which he expects to reach the break-even point. Nor can the appellant specify because of some unknown factors the time when he could pay off a substantial portion of the mortgage, the interest of which represents a very substantial expense.

Argument

The question to be determined having regard to the facts of this particular case is whether the Minister was right in disallowing the rental losses in computing the appellant's income for the 1984, 1985 and 1986 taxation years. The answer to this question depends on whether the appellant in renting the above property had a reasonable expectation of profit.

The evidence shows that the subject property produced rental income in 1982 and 1983. Moreover, the respondent admits that the appellant purchased the property in 1982 with the intention of producing rental income. However, the respondent assumed that "the appellant ceased in 1984, 1985 and 1986 taxation years to have a reasonable expectation of profit from his rental property". This assumption appearing in paragraph V(o) of the reply to the notice of appeal is curiously worded. The term "cease" implies that something has come to an end. It cannot be intended that the appellant's expectation of profit in relation to this property came to an end in each of the 1984, 1985 and 1986 taxation years. It probably means that the change of expectation must have occurred at a point in time in 1984 and that the new state of mind remained the same afterwards throughout the 1985 and 1986 taxation years.

On the evidence, there is no question that the abrupt change in the real estate market conditions caused the appellant to have second thoughts about his investment. The evidence establishes that subsequent to this slump in the real estate market, the appellant has considered selling the property on quite a few occasions but up to the date of the hearing of the present appeals, he had not disposed of the property. However, the appellant has maintained, in the course of his testimony, that he is interested in keeping this property in the hope that market conditions will improve. It can be inferred from the evidence that the appellant did not sell the property because he would have made a substantial loss. On the other hand, the appellant seems to be genuine about his hope of one day drawing income from this property.

I do not believe that the appellant can be considered to be a trader in real estate. He had thought about selling his property because of the unforeseen circumstances relating to the real estate market. One should not be surprised that a person with a clear investment intention could reconsider his position in the case of an unexpected and adverse turn of events.

At the trial of these appeals, counsel for the respondent attempted to establish that the taxpayer's intention had changed and that he wanted to dispose of his property to make a profit. In this regard, I do not believe that speaking generally an intention on the part of a taxpayer to dispose of a property is necessarily inconsistent with the purpose of earning income from that property before actually disposing of it.

The concept of a "reasonable expectation of profit” referred to in the definition of “personal and living expenses" found in section 248 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") has been considered by the Courts in various contexts. To start with it is appropriate to bear in mind the general principles laid down by Justice Dickson, as he then was, of the Supreme Court of Canada in the case William Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213 at 313-314 (D.T.C. 5215):

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

It is of particular interest here to consider the comments of Judge Bonner of this Court made in a renting loss type of situation in the case Gerald T. Mason v. M.N.R., [1984] C.T.C. 2003; 84 D.T.C. 1001 when he expressed himself as follows (at 2004 (D.T.C. 1001)):

The expectation of profit referred to in the definition of “personal or living expenses must be assessed objectively. Subjective optimism, no matter how sincere, does not meet the test. The appellant, in reaching a conclusion that the rent obtainable would cover carrying costs and then some, appears to have been more optimistic than realistic. His optimism was particularly pronounced in arriving at his projections of future rental revenues.

I also find that the comments of Judge Rip of this Court made in the context of a farming loss situation in the case of Paul J. Taillefer v. M.N.R., [1987] 2 C.T.C. 2137; 87 D.T.C. 418 to be instructive. He said this at 2141-42 (D.T.C. 421):

When determining if a taxpayer has a“ reasonable expectation of profit” one must place some emphasis on the word reasonable". Reasonable” is defined by the Shorter Oxford English Dictionary on Historical Principles as:

. . . 4. Not going beyond the limit assigned by reason; not extravagant or excessive; moderate . . .

The term reasonable expectation of profit” in the French language is "espoir raisonnable de tirer un profit". The word "raisonnable" is the equivalent of the word reasonable". Raisonnable" is defined by Le Petit Robert as:

. . . v. Naturel, normal . . . Qui consent des conditions honnêtes et modérées (commerçant, homme d'affaires, etc.), opposé à exigeant . .. 3. Qui correspond à la mesure normale . . . prix raisonnable.

The expectation of profit, therefore, is not a mere hopeful or wishful expectation; it is what a person having a basic knowledge of the undertaking would normally expect having regard to the various factors involved in the undertaking. If the undertaking is susceptible to the vagaries of weather (e.g., drought), disease, economics (e.g., fluctuating prices and costs) or other adversities beyond the taxpayer's control, that potential adversity must be taken into account in appreciating the meaning of reasonable”. Many of the adversities, beyond the control of the taxpayer, may be expected and are normal risks of farming but others are unusual and exceptional occurrences; the taxpayer ought to allow for the former in determining his expectation of profit. The term ” reasonable expectation” is not analogous to "expectation under ideal conditions”.

If a taxpayer starts his farming operations with a reasonable expectation of profit but incurs losses year after year the expectation of profit, for whatever reason, at a given time may cease to be reasonable and the taxpayer has to consider cutting his losses to minimize the continuing erosion of his personal net worth: Hadley v. The Queen, op cit, at page 68 (D.T.C. 5063).

Having regard to the observations made in the preceding cases, 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 that point must have been reached two or three years after the occurrence of the drastic change in the real estate market. With respect to the income-producing prospects of the property, I may add, although I do not have to decide the question, based on the evidence before me and the manner in which the financing of the property is presently arranged, that this property is not likely to yield income for many years to come. I therefore come to the conclusion that the appellant must have on the basis of an objective determination ceased by 1986 to have a reasonable expectation of profit from the rental of the property in issue.

For these reasons, I would allow the appeals for 1984 and 1985 and refer the assessments back to the Minister for reconsideration and reassessment on the basis that the rental losses are deductible in those years. The appeal for the year 1986 is dismissed.

Appeals allowed in part.