Dr. R. Hugill v. Her Majesty the Queen (Informal Procedure), [1994] 2 CTC 2221

Rip J.T.C.C.:— Dr. Russell Hugill has appealed income tax assessments for 1986, 1987 and 1988 taxation years (electing to proceed under the informal procedure of the Tax Court of Canada Rules), claiming that when he acquired three properties in 1982 he had a reasonable expectation of earning a profit from renting cottages on two of the properties. [1] Thus, he concludes, he ought to be permitted to deduct the losses from renting the properties in computing his income.

At the time of trial Hugill was 69 years of age. He practices dentistry in Toronto and is trying to build a practice in Elmvale, Ontario, about 20 miles north of Barrie, near the cottage properties. He works in Toronto about three days a week and in Elmvale a day a week. During the past twenty-five years he has spent parts of Thursdays and Fridays during September to May teaching dentistry at the University of Western Ontario in London.

The properties acquired in 1982 consisted of three individual lots. The north lot had two cottages on it, the south lot one cottage and the middle lot was vacant. The properties were on prime beach land near Wasaga Beach; each property had fifty feet frontage on Georgian Bay. The properties were also near Collingwood, Ontario, a popular ski area, and other ski hills. The three cottages had open ceilings, no insulation, open porches and outdoor plumbing.

The purchase price for the three properties was $148,000. Hugill paid $10,000 down and mortgaged the properties for $140,000.

The appellant was familiar with the area. The previous owner had rented the cottages for the summer and Hugill had been one of his tenants. Hugill’s parents also had owned a cottage in the area.

When Hugill purchased the properties, he said, he was looking forward to reducing the hours he worked as a dentist. He intended eventually to sell his practice and home in Toronto and move to Elmvale. He stated he would apply the proceeds from the sale of his home to pay down the mortgage on the cottage properties and winterize the cottages so that they could be rented during the winter. He also anticipated building two cottages on the vacant lot. Hugill was of the view the renting of the cottages "was such a reasonable business venture, it would have to do well".

Hugill also planned to install indoor plumbing in the cottages; in fact he rewired and installed plumbing in all three cottages and insulated the cottage on the south lot.

Hugill sold his Toronto practice in 1984. He originally agreed to stay on for several years to assist the purchaser. However, for financial reasons he continued to carry on the practice as an associate; he indicated he has suffered "some economic reverses" in recent years. However Hugill expressed in no uncertain terms his love for his profession and teaching.

The only advertisements for tenants for the cottages were signs placed on the properties by Hugill. He explained he was "fussy about tenants”. People would see the signs, telephone him in Toronto and arrangements would be made to meet at the property.

The appellant stated he and his wife personally did a lot of work improving the properties. He helped in winterizing the south lot cottage, plumbing and installing insulation. He also retained a handyman to maintain and check on the cottages.

Hugill declared neither he nor his family made personal use of the cottages. If he had to perform work on the properties he would stay at whatever cottage was vacant.

The appellant stated he kept a book recording his income and expenses from the properties.

Since acquiring the properties Hugill has added capital improvements aggregating $66,104.11. He used personal funds and some of the proceeds of the mortgage for the improvements. The bulk of the capital expenditures, $51,430, was incurred in 1986. The improvements included extending the cottages to provide plumbing and toilet facilities, insulation, wiring and digging a new well, amongst other things. A lack of money has prevented him from winterizing the other two cottages.

Hugill has only been able to rent the winterized cottage during the winter for the Christmas holidays. He expects that “eventually” he will be renting the cottage during the whole ski season; skiing is “booming” in the area. During the summer months the cottages have been almost fully rented.

In 1987, $130,849 was still outstanding on the mortgages and the mortgage was extended to 1989. During the years in appeal Hugill was paying interest only on the mortgage. The mortgage had been reduced significantly at one time but the property was refinanced later for "personal reasons".

Hugill never sold his home in Toronto, as originally planned. He explained the market value of the house had fallen and his equity in the home, which he planned to use to improve the cottages and to purchase a home in Elmvale, will not support his plans. He estimated the present value of his Toronto home to be $400,000; his equity in the house is $265,000.

Annexed to these reasons are the profits and losses ofHugill from the cottages for the period 1986 to 1992. Rental incomes for 1983, 1984 and 1985 were $2,725, $2,750 and $4,700 respectively; expenses were $7,218, $9,061 and $25,982 respectively for 1983, 1984 and 1985; losses in those years were $4,493, $6,311 and $21,282 respectively. [2] Hugill stated that without the mortgage it would have been easier to have shown a profit, although he was of the view that even with the mortgage a profit was possible. He originally had hoped the rentals would service the mortgage.

The appellant acknowledged much work remains to be done on the cottage properties in order to rent them during winter months. Hugill agrees that if he cannot rent the cottages during the ski season it will be difficult for him to make a profit. The lots have increased in value. Hugill stated they have been appraised at $590,000. The amount still owing on the mortgage on the lots is $135,000.

The calculations contained in the attachment were made by Hugill’s accountant, Leslie Solomon, C.A. Solomon stated that the loss for 1988 ought to be increased since he failed to claim interest paid on the mortgage when he prepared Hugill’s 1988 tax returns. The amount of interest paid in 1988 was $15,701.88. Property tax is included in “expenses”. The witness suggested property tax in- creased significantly in the mid 1980s to an amount not reasonably foreseen in 1982. Later Hugill testified that the amounts of interest and property tax included in expenses were amounts actually paid by him, not necessarily amounts owing or assessed by local authorities.

Several months ago Solomon prepared a document referred to as a business plan for Hugill. The document summarizes projected income for 1983 to 1991. Solomon said that in making the projections he made assumptions that would have been valid in 1982. These assumptions include inflationary increases until 1990, the construction of another cottage to increase rents, the proceeds of sale of the appellant's home in Toronto being used to improve the properties, and renting the cottages during winter once they were winterized. In Solomon's view the appellant would have a "nice retirement business". The projections prepared by Solomon are as follows:

The Deputy Attorney General of Canada pleaded that during the years in appeal Hugill did not own rental properties for which he was entitled to rental losses. In the alternative, he submitted that the appellant had no reasonable expectation of profit from renting the properties during 1986, 1987 and 1988, that the losses were personal or living expenses of the appellant and that he was properly assessed in accordance with paragraphs 18(1)(a) and 18(1)(h) [3] of the Income Tax Act, R.S.C. 1952 c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

The term “business” is defined by subsection 248(1) of the Act to include a profession, calling, trade, manufacture or undertaking and . . . an adventure or concern in the nature of trade. The Act in many of its provisions distinguishes between income from business and income from property. Rental property in certain circumstances may constitute a business and the rentals are income from a business; on the other hand the rental property may be simply rental property unconnected to any business and the rentals from the property are the source of income to the taxpayer. Business and property, amongst other things, are sources of income.

In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, Dickson J., as he then was, wrote, at page 485 (C.T.C. 313, D.T.C. 5215):

. . .in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit.

The term ''personal or living expenses" includes, amongst other things:

248(1)(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,

The issue in Moldowan, supra, was whether a taxpayer's chief source of income was either farming or a combination of farming and some other source. Dickson J. stated that if a taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

The definition of “personal or living expenses" cannot and does not suggest that expenses of property not maintained in connection with a business carried on for profit or with a reasonable expectation of profit are in all circumstances "personal or living expenses". Expenses of properties maintained for the purpose of obtaining income from rents or some other source that is not a business are not necessarily “personal or living expenses”. Where a property is acquired and held "prima facie?' for the purpose of earning income and not for the personal use and benefit of the owner or anyone related to him or her, the expenses of such property cannot be said to be personal or living expenses. However that is not to say the expenses from maintaining such property are always deductible in computing income from property in accordance with either paragraph 18(1)(a) or 18(1(h).

To determine whether such expenses are deductible in computing income from a property one must apply the principles to determine whether an expense is deductible in computing income from business. To have a source of income the taxpayer must have a profit or reasonable expectation of profit from that source which includes a rental property. It is for this reason that a source of income is an equivalent term to business: Moldowan, supra. A taxpayer may maintain property for the purpose of earning income and not for his personal use or benefit, but only deduct expenses from maintaining the property if he or she has a reasonable expectation of profit from that property. Similarly an amount paid in the year by a taxpayer or payable by the taxpayer in respect of the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from property or on an amount borrowed to acquire property for the purpose of producing income therefrom may be deducted by the taxpayer in computing income for the year pursuant to subparagraphs 20(1 )(c)(i) and (ii) if he or she had a profit or reasonable expectation of profit from that property.

Whether a taxpayer has a reasonable expectation of profit is to be determined objectively from all of the facts. Dickson, J. suggests the consideration of some criteria, although he cautions that his list of criteria is not exhaustive. He also appreciates that the factors will differ with the nature and extent of the undertaking. The criteria Dickson, J. states should be considered are: the profit and loss expenses 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. Moldowan, supra, page 485 (C.T.C. 313, D.T.C. 5215).

I have no doubt that Hugill had good intentions in 1982 when he acquired the properties. He realized that to make a profit from the properties he would have to extend the time they were available for rent. This meant, at a minimum, winterizing the cottages and installing indoor plumbing, Hugill also foresaw the construction of two additional buildings. The projections prepared by Solomon are premised on Hugill realizing his plans and provide for the development of an additional lot, which I interpret to mean the construction of a fourth cottage, in 1990. The projected profits for 1989, 1990 and 1991 do not take into account capital cost allowance which, if deducted, may result in a loss.

I appreciate that the owner of property rented during tourist seasons cannot be expected to make a profit from the property as quickly as the owner of similar property which is rented throughout the year. However within some reasonable time, the rental income should exceed costs.

In fact Hugill winterized only one cottage although he installed indoor plumbing in all three cottages and rewired all the buildings. He did not continue improving the properties because to do so was costly and he did not have the money. He paid $148,000 for the properties and spent $66,104.11 improving them. He had paid down substantially the mortgage but had to refinance the properties when he ran into financial difficulties. Hugill did not sell his Toronto residence when real estate values in Toronto were high and the value of his home has fallen since. The equity in his home, were he to sell it today, would not be sufficient to finance his original plans for the cottage properties. Hugill’s financial reverses have also retarded his plans. He remortgaged the cottage properties to assist him with his personal finances. In short, the venture has been, and continues to be, undercapitalized.

During the years in appeal Hugill did not have a reasonable expectation of profit from the cottage properties. He devoted time and whatever money he had available to improve the properties. The nature of the venture is risky in that the properties are rented for only a limited time during the year, and as capitalized during the years in appeal, did not and could not reasonably show a profit. Hugill suffered losses since he acquired the properties and he realizes that improvements have yet to be made to the properties if he is to make a profit from renting them during the summer and ski seasons.

Accordingly, I shall dismiss the appeals.

Appeal dismissed.