William P Perratt, Ruth Perratt v. Minister of National Revenue, [1985] 1 CTC 2089, 85 DTC 101

Taylor, TCJ:—These are appeals heard on common evidence, on November 23, 1984 in Toronto, Ontario, against income tax assessments for the years 1979 and 1980 in which the Minister of National Revenue disallowed, as deductions from other income, rental losses claimed by the taxpayers. The notice of appeal read:

We hereby appeal the disallowance of rental losses for 1979 and 1980 on our Florida rental property because they were considered to be “a personal or living expense” and not “outlays or expenses incurred by the taxpayer for the purpose of gaining or producing income”.

The decision to disallow losses of a new business based on only two years of operation tends to give an inaccurate view of income producing potential. Start up costs are usually high and rental income low until an advertising programme provides repeat and referral business. Further a planned and implemented yearly increase in rental rate structure takes time to be effective in increasing income . . . Below are the tabulated results that show four years of operation which more accurately indicate the expectation of profit from our rental business.

	Weeks
Year	rented ted	Income	Expenses	Loss Loss	Split
1979	10	3,776.96	20,675.66	16,898.75	8,449.37
1980	18	7,247.80	25,035.43	17,787.62	8,893.91
198]	20	9,611.02	24,737.26	15,126.24	7,563.12
1982	36	15,654.56	22,100.00	6,445.44	3,222.72

The above operating results reflect the adverse effect of high interest rates. The decision to purchase this property was based upon a maximum of 10% rate, but in fact, rates rose above 23% during the rate peak. Plans are in process to take new financing so that all of the debt on the property is at a fixed lower current rate.

The property has been licensed each year, by the City of Sanibel as a “condominium rental — 2 bedrooms”, to transact business. A copy of the original license, taken out in 1979 indicates the intention of this business meeting its legal requirements. Every effort has been made to rent the apartment as much as possible by advertising. Globe and Mail and Star advertising costs for 1982 were $615. Consistent efforts are made to service all aspects of the business and thus reach the point where it is profitable. We are making good progress and trust you will agree that we have made these expenditures with a reasonable expectation of profit.

And the position of the respondent was detailed in the reply to notice of appeal as follows:

On or about November 30, 1978, the Appellant acquired a condominium in the State of Florida, one of the United States of America, more particularly described as Unit 584, Loggerhead Cay Condominium, 666 Beach Road, Sanibel Island (the “Condominium”).

The Condominium was acquired for the purchase price of $86,000.00 US including furnishings valued at $3,000.00 US. The Appellant financed the purchase price of the Condominium by obtaining a loan in the amount of $62,250.00 secured by a first mortgage on the Condominium in the amount of $62,250.00 bearing interest at the rate of 9/,% per annum for a term of 25 years and by obtaining a second loan of $30,000.00 secured by a collateral mortgage on his principal residence in Canada and bearing interest at a rate of 2/,% above the prime rate for a term of approximately 7 years.

Since the acquisition of the Condominium, the Appellant has attempted to rent the Condominium when it was not being used as a vacation home by the Appellant and his family. The following are the particulars of the gross rent and expenses relating to the Condominium as claimed by the Appellant in his 1979 and 1980 Income Tax Returns:

ITEMS	1979	1979	1980 1980
Gross Rent		$ 3,776.92	$ 7,247.81
EXPENSES
Property Taxes		$ 2,770.90	$ 1,661.94
Maintenance and Repairs		1,706.62	5,923.92
Interest		12,474.67	12,363.74
Insurance		101.92	120.41
Light, Heat and Water		490.72	932.96
Telephone		234.64	258.50
Condo Management Fees		2,032.26	2,137.34
Advertising and Licence		314.97	1,103.85
			(includes Rental
			Commissions)
Rental Commissions		548.96	—
Clean-up Service		—	532.77
TOTAL EXPENSES CLAIMED		$20,675.66	$25,035.43
LOSS		($16,898.74)	($17,787.62)

The Respondent relies, inter alia, upon sections 18 and 248 of the Income Tax Act, RSC 1952, Chapter 148, as amended.

The testimony of Mr Perratt (for both appellants) in addition to confirming the basic assertions of the respondent (supra) established that:

— the appellants had little or no prior experience in the rental field — Mr Perratt agreed they were probably “naive” both with regard to their hopes and in their acceptance of income projections given to them by others.

— neither appellant had taken any specific training with regard to real estate ownership or rental management.

— before acquisition, they were aware of and considered the prospects of eventual retirement in the condominium, and the anticipated (at least indicated) asset value appreciation — which might cover probable losses.

— they had no funds of their own in the project.

— losses continued in 1983, and 1984, even though gross rentals had increased somewhat.

— the Florida property now had an estimated sale value of $130.000.

— the appellants had spent certain vacation times in the condominium during the years in question and subsequently.

Counsel for the respondent referred the Court to the decisions in Moldowan v The Queen, [1977] CTC 310; 77 DTC, 5213, and Arbus v MNR, [1980] CTC 2872; 80 DTC, 1744. I would add the following: Warden v MNR, [1981] CTC 2379; 81 DTC 322, G Cecato v MNR, [1984] CTC 2125; 84 DTC 1110.

I recognize that there was considerable effort on the part of these taxpayers to rent the condominium, and in that way it may appear to differ from Arbus (supra) in the opinion of Mr Perratt. However, I would point out the succinct and critical phrase in Arbus (supra) which says it all:

. . . It may very well be that the losses in fact experienced were worse than anticipated, but I have concluded that from the outset, losses, and not profits, were both predictable and predicted and the expenses were therefore not incurred for the purpose of gaining or producing income.

I am satisfied that these appellants firmly and honestly believed — (perhaps from less than accurate tax advice or from some other source) — that the program which they put together in acquiring and holding available for rent, the condominium, entitled them to the tax deduction they seek for the losses they incurred. I am not aware of jurisprudence which would support such an opinion, and I would refer to a quotation from Cecato (supra) to be found at 2128 and 1112 respectively:

. . . So-called “rental losses” are not deductible from other income when a reasonable expectation of profit has not been demonstrated. It would appear to me a misrepresentation of the Act to unreservedly attribute “tax shelter” characteristics to all rental operations.

It would seem to me that when a taxpayer acquires a real property in a normally vacation area; in a foreign country; which will require local attention and probably local management; which can be and often is used personally for vacation purposes; with little or no down payment; and is in a highly competitive and compressed rental market; he should be very wary of any “siren song” which could lead him to believe that operating losses sustained will be a legitimate deduction from other income. That must be particularly true if a serious recognition of an interest in the potential of the property for personal retirement use, or capital appreciation can be seen. Certainly a rather unique “rental” situation may arise in which the Courts could find for a taxpayer, but I am persuaded that the circumstances of this case do not come any place close to such a theoretical prospect for a tax deduction.

The appeals are dismissed.

Appeals dismissed.