Thomas R. McGovern and Carol F. McGovern v. Minister of National Revenue, [1993] 2 CTC 2210, 93 DTC 1001

Rip, T.C.C.J. (orally):— I've prepared the notes for reasons for judgment, and I do reserve the right of course, if necessary, to polish these notes up.

In assessing Thomas R. McGovern and Carol F. McGovern (the McGoverns") for 1984, the Minister of National Revenue, (the respondent"), disallowed expenses claimed by the McGoverns with respect to a condominium unit they jointly owned at Paul Lake near Kamloops, British Columbia, which I'll refer to as the unit, on the basis that there was no reasonable expectation of profit in that year in respect of the unit. The assessments were issued in accordance with subsection 248(1) of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), which defines personal property, and the expenses which were not allowed were not allowed in accordance with paragraphs 18(1)(a) and 18(1)(h) of the Act.

The McGoverns have appealed their assessments arguing there was a reasonable expectation of profit from the property. The appeals were heard on common evidence and Mr. McGovern, (referred to as McGovern"), was the sole witness.

The appellants acquired the property in December, 1980, during its construction. The unit, one of 30 in the condominium, was approximately 1,500 square feet in area on lakefront property and within walking distance to a modest ski resort. The purchase price of $87,659 was financed by way of a first mortgage of $76,000, having an annual interest rate of 14 A per cent during its four year term. The monthly mortgage payment on account of principal and interest was $933.29. The McGoverns owned a furniture business in Calgary at the time, but had no experience in real estate rentals.

McGovern testified that in 1980, he and his wife were looking for rental property in Calgary when the unit was brought to his attention through a real estate agent, who also eventually purchased another unit in the condominium. Because of the property's proximity to leisure activities, the McGoverns considered the condominium property ideal for year round vacations and purchased the unit to earn an income by renting it out to families for periods of from one to two weeks during the winter and summer seasons. The unit qualified as a multiple unit residential building, a MURB, for capital cost allowance purposes in accordance with class 31 in the Schedule 2 of the Regulations to the Act. McGovern testified that the MURB quality of the unit was an attraction which influenced its purchase by him.

The unit contained three bedrooms and was completely furnished with beds, refrigerator, stove, washer, dryer, sofa, tables, television, et cetera. This was furnishings undertaken by the McGoverns. McGovern estimated six people could stay comfortably in the unit.

McGovern produced a schedule of projected rentals and expenses that he prepared in 1981. He was looking to the Calgary market and geared rates, for example, to holidays on Calgary schools’ calendar. He testified he set the rates by verifying what was available to Calgary families, rates of hotels in the area and considered the facilities he was offering. He did not go into detail. He calculated a revenue potential based on a rental of 365 nights per year, but to be realistic, considered a 50 per cent occupancy rate at $750 per week. He considered gross monthly rentals would thus total $1,950 and expenses for the year would aggregate $14,426. Thus, in the first year he would have a profit. These projections do not provide for capital cost allowance or costs of repair and maintenance.

When he acquired the unit in 1980, there were no restrictions on the use of the unit by the owners. However, in the spring of 1981, a condominium association was formed and proposed by-laws for the condominium were drafted. The proposed by-laws restricted the owners to use their units only as a private dwelling house for one family and did not permit children under the age of 12 to be resident in the unit. The McGoverns and the agent who introduced them to the project lobbied against these proposals, but were not successful. The plans of the McGoverns to rent on a short-term basis was scuttled. They thus revised their plan and sought long-term tenants.

In 1981, McGovern says he prepared a summary of projected revenue and expenses on monthly leases, based on monthly rentals of $800, $1,000 and $1,200 respectively. He included expenses only of mortgage interest and property taxes. The schedule also appears to include payments of principal on their mortgage as an expense as well. I note that the payment on principal would have been an extremely small amount, and I do not place any great significance on this.

McGovern made provision for capital cost allowance to show a monthly loss of $508.57, $308.57 and $91.43 respectively on rentals of $800, $1,000 and $1,200 respectively. There is no provision in the expenses for repair and maintenance, condominium fees, hydro, although the latter may have been paid by the tenant. The documents, McGovern acknowledged, was a "very rough document" and was more for his own thinking than anything else. In any event, McGovern was of the view that he could earn profit from the unit with a longterm tenant.

Now, according to the evidence, it appears that McGovern considered profit to include the tax advantage he would have gained from the MURB quality of the unit. In 1981, a long-term tenant was obtained at a monthly rental of $800.

McGovern stressed that there were factors beyond his control that affected the profitability of the unit. They were (a) the pool and the tennis court of the condominium were not available for the summer of 1981; (b) high interest rates were prevalent commencing in 1981; (c) Kamloops had a high vacancy rate in 1981; and (d) his first tenants vacated the unit after six months.

After the tenants vacated the unit, McGovern tried to rent the unit through a real estate agent in Kamloops. A second tenant was found in 1982, and the unit was leased on a month-to-month basis. Furniture was removed from the unit by McGovern on the advice of a real estate agent, since prospective tenants already residing in Kamloops would tend to want their own furniture. The monthly rental to the second tenant was $500.

McGovern claimed expenses and capital cost allowance in preparing his income tax returns for 1981, 1982 and 1983, and they were accepted by the respondent. In 1984, their claims were not allowed. Now, this also applies to Mrs. McGovern.

McGovern ceased to make any payments on account of the mortgage or to the condominium with respect to condominium charges in 1982. The mortgagee initiated foreclosure proceedings against the McGoverns in 1982. During 1984 and 1985, the McGoverns received no rent from the unit. It was vacant. The total rents they received were $3,200 in 1981, $1,500 in 1982, $3,300 in 1983. Expenses claimed in 1982 were $12,100 without capital cost allowance, $11,410.64 plus $3,546.51 as capital cost allowance in 1983 and $10,531.52 plus $3,363 of capital cost allowance in 1984.

As I previously stated, the unit was not rented during 1984 and 1985. Since 1982, the McGoverns have relied upon a real estate agent in Kamloops to find tenants, although advertisements were placed in Calgary newspapers to rent the unit at $1,200 a month. There were three or four inquiries, according to McGovern, but no tenant was found for that amount.

On May 4, 1983, the Supreme Court of British Columbia issued an order nisi, declaring the McGoverns in default on the mortgage and that all moneys so secured was due and owing to the mortgagee. The last date of redemption was November 3, 1983, and the amount due was $92,562.04. The Court also foreclosed the McGoverns from all rights, title, interest claim, estate and equity in the unit if the money was not paid prior to November 3, 1983, and the mortgagee received vacant possession.

The order absolute was issued in August 1985, but according to McGovern was never served on him. I assume that neither was it served on his wife. McGovern testified that his solicitors were negotiating during this time with the mortgagee until 1985, and the matter was settled and the unit was disposed of.

At the time in 1982, the McGovern's business in Calgary also went in receivership. This is one of the reasons, McGovern stated, they ceased making payments on the condominium unit.

Some time in 1982, McGovern made efforts and engaged a real estate agent to sell the unit. The agent was seeking tenants, notwithstanding the Court's order nisi. With a lease in hand, McGovern said, he thought he could convince the mortgagee of the bona fides of the unit as an investment.

According to their accountant, in a letter to Revenue Canada, the property was offered for sale in 1982 in an attempt to stop further losses. McGovern testified his accountant erred in giving this information to Revenue Canada. The property was available for sale or rent, he said.

According to McGovern, things were picking up” in Kamloops in 1984, and the local economy was improving. On a monthly rental of $800 he affirmed, he could have turned a profit on the unit. He was prepared to refurnish and rent the unit at $800. He did not adduce any evidence as to how he could then turn a profit at $800 a month in 1984, bearing in mind, for example, his interest burden would have increased, due to the non-payment of principal since 1982.

McGovern calculated monthly rent of $1,200 based on $60 per square foot of living space, plus a nominal amount for furniture times one per cent. To my calculations, $60 times 1,500 square feet times one per cent equals $900 per month, not $1,200.

No evidence was adduced at trial to show firstly, in 1981, who would manage and how the amount and how the unit would be supervised, as it was rented to tourists on a weekly basis. There was obviously no arrangement for the condominium corporation to perform these tasks. The person performing this work would require a fee. There was no evidence of the actual marketing program to be undertaken of the rental of the single unit or from persons experienced in the business that it was capable of success, even with an absentee owner.

There was no evidence, except for McGovern's testimony, of the general rental market in Kamloops from 1981 to 1984, and his evidence was rather general in nature.

The evidence I would have preferred would be the type of accommodations that were prevalent in the Kamloops region, the low and high ends of the market and how this particular unit fit in. I think that such evidence would have been of assistance to the Court. The testimony of the agent who purchased the unit at the same time as the McGoverns, who introduced them to his property, may have been helpful as well. How did he fare, and what, if anything, did he do differently than the McGoverns?

The McGoverns were not experienced in the real estate market in general and in Kamloops in particular. When they looked at properties and spoke to friends in Kamloops, were they asking the right questions? Were they getting the right answers that would assist them? Could Mrs. Hickey, for example, a real estate agent who lived in another unit in the condominium property, have added to the evidence?

Counsel for the appellants referred the Court to the decision of Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, a decision of the Supreme Court of Canada. In his reasons for judgment, Dickson, J., as he then was, set out at page 486 (C.T.C. 313-14, D.T.C. 5215) a partial list of what criteria to use to determine the existence or not of a reasonable expectation of profit.

In the appeal at bar, the profit and loss experience in years prior to 1984 does not aid the appellants. The training of the appellants in renting real estate is absent, although they did carry on a business in previous years. The capitalization for the purchase of the venture relied on a mortgage of approximately 85 per cent of the purchase price and the funds to pay the interest on the mortgage were to be generated from the unit itself. Once CCA was taken while the unit was owned by the McGoverns, the loss was exacerbated.

The decisions of McNeil/ v. The Queen, [1989] 2 C.T.C. 310, 89 D.T.C. 5516 (F.C.T.D.), Ahluwalia v. M.N.R., [1987] 2 C.T.C. 2300, 87 D.T.C. 592, Baker v. M.N.R., [1987] 2 C.T.C. 2271, 87 D.T.C. 567 (T.C.C.), and Dorchester Drummond Corp. v. M.N.R., [1979] C.T.C. 219, 79 D.T.C. 5163 (F.C.T.D.), do not, in my view, aid the appellants. It is trite law that each case is determined on its own set of facts.

Counsel for the appellants submitted the facts in McNeil], supra, are on all fours with the present case. In the case at bar, I cannot find the so-called projections prepared by McGovern to be reasonable, for reasons already mentioned, and that in 1984, faced with an increasing liability to the mortgagee, the McGoverns could have rented the unit at a profit in that year, or even within a reasonable time thereafter.

I think their accountant was right when he advised Revenue Canada the property was for sale in order to cut the losses. Unlike the facts in Ahluwalia, supra, there was no on-site manager of the condominium nor were there rental operations to be handled on-site as well.

In my view, in 1984, the McGoverns had no reasonable expectation of profit from their unit. The expenses were not laid out to earn income from a property or business. The unit was their personal property. Thus, the deduction of expenses is prohibited by paragraph 18(1)(a) as well as paragraph 18(1)(h) of the Act. The appeals are, therefore, dismissed.

Appeal dismissed.