Dr. Clare B. Baker v. Minister of National Revenue, [1987] 2 CTC 2271, 87 DTC 566

Couture, C.J.T.C.:—The appellant appeals from assessments made on October 5, 1983 in respect of his 1978,1979 and 1980 taxation years.

A number of matters that were in dispute have been disposed of by agreement between the parties. The only question left is whether the appellant had a reasonable expectation of profit from the leasing of a property he owned in Florida. If the answer is yes he is entitled to deduct the losses he incurred from this activity during his 1978, 1979 and 1980 taxation years. If the answer is no the appeal must be dismissed.

These are the salient facts. In January 1978 the appellant, a physician who practised in Toronto, purchased a semi-detached house (hereinafter referred to as "the property") on Stonybrook Drive in Boynton Beach, Florida. Stonybrook Drive is located some seven miles inland from the Atlantic Ocean. The appellant testified that his purpose in making this acquisition was to secure an income-producing investment. He said that he was not interested in the securities market and regarded real estate as better suited for his investment objectives. In 1975 he had purchased a triplex in Toronto that he still owned at the time of the hearing as part of a real estate investment portfolio. According to the information in a capital cost allowance schedule filed with his income tax returns for the taxation years under appeal the price of the building excluding land was $94,478. After the sale of the property in 1980 he purchased other real estate in Toronto as a revenue yielding investment at a cost of $260,000 which amount also did not take into account the cost of the land. The appellant reported net professional income for the taxation years under review of $156,108, $161,120 and $173,509 respectively.

It appears that his decision to invest in Boynton Beach was influenced by a friend of his who had purchased some property there, and also by the sales pitch of the sales agent of the contractor who was developing the area where the property is. The appellant was informed at the time by the agent that there would be no difficulty in renting the property. He had also visited the area a couple of years before and was familiar with it.

From the appellant's description of the property it seems that he was justified in relying on the agent's representations regarding the prospect of easily renting the property. It was located in a very attractive area along a golf course where the price of houses ranged between $70,000 and $90,000. At the time there were also large houses in the $300,000 to $400,000 class being built on the fairways. The appellant paid $80,000 for the property.

Additionally there was a completed development across the road from the development that included the appellant's property. The homes there were at the time continually totally rented. Therefore to the appellant the financial prospect of his proposed investment appeared quite favourable. The agent suggested a rent of $500 a week or $1,000 a month for a long-term lease.

Early in 1978 the appellant furnished the house at a cost of some $15,000 and made arrangements for its maintenance throughout the year. A gardener was hired who in addition to his other duties was responsible for security. In spite of the sales agent's assurances and the appellant's own conclusions regarding the possibility of renting the property, it was leased sparingly during the period from January 1978 to May 1980 when it was sold.

In 1978 the appellant and his wife occupied the house for two weeks and later for an additional week. This was for the purpose of furnishing the house. In his records regarding the property, $1,500 in rent is attributed to these three weeks and was declared as income from that source. The appellant informed the Court that his wife did not enjoy Florida. The property could not be considered as a vacation retreat because she refused to holiday there. He also succeeded in renting the property for another month in that year for $1,000. The total rental from the property in 1978 was $2,500. In 1979 the appellant rented the property from December 15, 1978 to April 15, 1979 for which he received $4,000. Because of the failure of the sales agent in Boynton Beach to rent the property the appellant had his secretary place ads in Toronto newspapers advertising the availability of the property for rent, but again without success.

At the end of 1978, Cadillac Fairview acquired the development where the property was and began constructing houses. As the number of houses increased the opportunity to rent the property decreased. The appellant realized that he was involved in a losing proposition, that the glowing image that had been projected to him respecting the financial soundness of his investment was superficial and its lustre was fading as time went by. He listed the property for sale in May 1979 and it was sold in 1980 for $115,000.

Prior to purchasing the property the appellant consulted his accountant who made some projections based on certain assumed facts, and advised him that there was a possibility of realizing a profit in the third year of operation. The accountant, Leo Vinette CA, testified on behalf of the appellant. He confirmed that from the information he obtained from his client he had projected that as soon as the property was rented for a minimum of 30 weeks in a year the excess would be profit, that is, anything over $15,000 in rental income would give rise to a profit. He also asserted, again based on the information available at the time, that he thought the proposed acquisition by his client was, to use his words, a fair investment and he so informed his client.

The appellant claimed deductions for these losses in the taxation years under appeal:

1978— $16,272.49 1979— $12,369.32 1980— $17,759.44

Vinette was fairly close to the reality in his projections, considering the above losses and particularly the fact that the appellant had to borrow an additional $15,000 to satisfy a mortgage on the land the existence of which was unknown at the time of his computations of the operating costs of the property. It was only discovered when Cadillac Fairview acquired the development at the end of 1978.

As indicated at the commencement of these reasons the question that must be answered is whether under the circumstances I have described the purchase of the property by the appellant offered him a reasonable expectation of profit.

Dickson J. (as he then was) in William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 said at 313 (D.T.C. 5215):

There is a vast case literature on what reasonable expectation of profit means and it is by no means consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all the facts.

I understand this to mean that a reasonable expectation of profit exists where given all the facts pertinent to a venture it could, within a realistic time (the period will vary depending on the nature of the operation), yield a profit barring abnormal circumstances. In other words, is the venture as structured and normally operated capable of generating a profit?

In a number of appeals reported in the jurisprudence the Courts answered no to this question because the venture that was the object of the litigation could not, in the opinion of the Court, achieve that objective for a number of reasons, but mainly because the likelihood of its being financially successful was only a dream in the mind of the operator and rested entirely on his subjective aspirations and hopes which were unrealistic.

In the present appeal, it appears to me that the appellant conducted himself like a normal average investor, an investor who was not sophisticated because of lack of professional training, but who nonetheless had a working knowledge of the basic rules of the investment process. He knew the area where the property was located. He had received assurances from the real estate agent that there would not be any problem renting the property throughout the year and furthermore the agent had indicated the rent that could be obtained. Being familiar with the area and with the situation with regard to the development across the road, he regarded the proposal as reasonable. Also before buying the property he had consulted his accountant. Of course, risks are inherent in most business undertakings of the kind under discussion.

The key feature of the appellant's financial success with regard to his investment was the requirement of a 30-week minimum occupancy, a minimum which I do not regard excessive in the circumstances. The fact that the rental projections did not materialize, which was the main and only cause of the failure of the venture certainly cannot be imputed to the appellant. It was simply part of the risk related to the venture.

The fact that the existence of a mortgage on the land was discovered over a year after the appellant acquired the property was a contributing factor to the failure of the venture. That the appellant did not obtain independent legal advice with regard to the title to his property may indicate a lack of prudence on his part, but in spite of the added financial burden created by the mortgage, it was not of sufficient importance to displace the presence of a reasonable expectation of profit.

The appeals for the 1978, 1979 and 1980 taxation years are allowed and the assessments are referred back to the respondent so that an amount of $1,200 of bank interest be deducted in computing the appellant's income for the 1980 taxation year and also that losses amounting to $16,272.49, $12,369.32 and $17,759.44 for the 1978, 1979 and 1980 taxation years respectively be allowed in the same computation of income.

The appellant is entitled to his costs on a party-party basis.

Appeals allowed.