Lewitzky v. R., [1998] 1 CTC 3312

O’Connor T.C.J.:

This appeal was heard at London, Ontario on August 8, 1997 pursuant to the Informal Procedure of this Court.

The Appellant was represented by his agent, Keith R. McLaren, a Certified Management Accountant. Testimony was given by both the Appellant and the agent.

Issue:

The only issue in this case is whether the Minister was correct in disallowing certain rental losses in the years 1992 through 1994.

Facts:

The material facts are as follows:

The Appellant purchased a three room bungalow in Guelph, Ontario in August, 1990 at a price of $146,000. The first mortgage on the property was $109,000 with an interest rate of 14% for a term of one year but amortized over a 25 year period. The second mortgage was $16,500 with an interest rate of 17 A%. When renewed, the interest rate on the first mortgage dropped to 10% for six months and then when renewed again it dropped to 7% for six months and at the present time and for some time now has been 6%. The second mortgage interest rate of 17% was in 1994 altered to a line of credit carrying an interest rate of 8 41%.

The Appellant lived in the basement apartment and rented the remainder of the bungalow initially for $900 per month for the months of September through December, 1990. The bungalow then was vacated and rented again from February, 1991 for three months at a rental of $850 per month. The bungalow became vacant again in May or June, 1991 and was then rented again for the months of July, August and September, 1991 and one week of October at a monthly rental of $800. It was vacated again and then subsequently rented in November, 1991 at a rent of $500 per month. The tenants all left principally because they found the rent too high, the parking was inadequate and the bungalow required renovations. In 1992, 1993 and 1994 the rent varied between $530 to $566 per month. Commencing February 1, 1995 the rent rose to $780 per month and this continued through 1996. When vacancies occurred the Appellant constantly advertised the bungalow for rent at rates varying from $800 to $875.

The losses claimed were: $3,902.60 in 1992, $5,251.92 in 1993 and $2,061.44 in 1994. Schedules “A”, “B” and “C” to the Reply to the Notice of Appeal detail the rental income and the expenses claimed on the Appellant’s income tax returns as follows:

Schedule ‘A‘

Nick Lewitzky

Reply to Notice of Appeal

RENTAL INCOME AND EXPENSES

	FOR 1992 TAXATION YEAR
GROSS INCOME					$6,800.00
	Total	Personal		Deductible
	Expenses	Portion		Amount
EXPENSES
Property Taxes	$ 1,505.89	501.96		1,003.93
Maintenance and Re-	703.62	-0	-	703.62
pairs
Interest	11,232.31	3,744.10		7,488.21

Schedule ‘A‘

Nick Lewitzky

Reply to Notice of Appeal

RENTAL INCOME AND EXPENSES

	FOR 1992 TAXATION YEAR
GROSS INCOME					$6,800.00
	Total	Personal		Deductible
	Expenses	Portion		Amount
EXPENSES
Insurance	246.00	82.00		164.00
Light, Heat, Water	1,790.45	477.61		1,342.80
Total Deductible Ex					10,702.60
penses
Net Income (Loss)				($ 3,902.60)
before capital cost al
lowance
Deduct: reported by					-0	-
co-owner
Net Income (Loss)				' (	3,902.60)
From Real Estate
Rentals
	Schedule ‘B‘
	Nick Lewitzky
	Reply to Notice of Appeal
RENTAL INCOME AND EXPENSES
	FOR 1993 TAXATION YEAR
GROSS INCOME					$6,250.00
	Total	Personal		Deductible
	Expenses	Portion		Amount
EXPENSES
Property Taxes	$1,508.40	502.80		1,005.60
Maintenance and Re	3,168.74	-0	-	3,168.74
pairs
Interest	8,658.82	2,886.27		5,772.55
Insurance	270.00	90.00		180.00
Light, Heat, Water	2,062.54	687.51		1,375.03
Total Deductible Ex					11,501.92
penses
Net Income (Loss)				($ 5,251.92)
before capital cost al
lowance

Schedule ‘B‘

Nick Lewitzky

Reply to Notice of Appeal

RENTAL INCOME AND EXPENSES

	FOR 1993 TAXATION YEAR
GROSS INCOME					$6,250.00
	Total	Personal	Deductible
	Expenses	Portion		Amount
EXPENSES
Deduct: reported by					-0
co-owner
Net Income (Loss)					5,251.92)
From Real Estate
Rentals
	Schedule ‘C‘
	Nick Lewitzky
	Reply to Notice of Appeal
RENTAL INCOME AND EXPENSES
	FOR 1994 TAXATION YEAR
GROSS INCOME					$6,800.00
	Total	Personal		Deductible
	Expenses	Portion		Amount
EXPENSES
Property Taxes	$1,505.24	501.75		1,003.49
Maintenance and Re-	582.94	-0	-	582.94
pairs
Interest	7,721.86	2,573.96		5,147.90
Insurance	428.48	142.83		285.65
Management and Ad-	85.00	28.33		56.67
min.
Motor Vehicle Ex-	45.00	-0	-	45.00
penses
Light, Heat, Water	1,949.69	649.90		1,229.79
Total Deductible Ex					8,421.44
penses
Net Income (Loss)					($2,061.44)
before capital cost al
lowance
Deduct: reported by					-0	-
co-owner
Net Income (Loss)					($2,061.44)
From Real Estate
Rentals

At the hearing the Appellant agreed that only two-thirds of the expenses were applicable to the rented premises (on the basis of square metre measurements) and that the Minister was correct in the assumptions in paragraphs 6 (g), (h) and (i) of the Reply to the Notice of Appeal which read as follows:

(g) in the 1992 taxation year, the Appellant claimed repair and maintenance in the amount of $703.62 which included unvouched expenses and personal expenses in the amount of $200.75;

(h) in the 1993 taxation year, the Appellant claimed repair and maintenance in the amount of $3,165.74 which included capital expenditures in the amount of $1,003.85 and unvouched expenses and personal expenses in the amount of $371.96;

(i) in the 1994 taxation year, the Appellant claimed repair and maintenance in the amount of $582.94 which included unvouched expenses and personal expenses in the amount of $155.57;

After adjusting for the foregoing, the final amounts of the rental losses in dispute in these appeals are as follows:

The Appellant testified that he could have turned a profit in the early years of the rental operation based on the initial rental obtained of $900 per month and considering the rapid lowering of interest rates. However, rental rates declined dramatically in the early nineties. In fact, because of the lowering of interest rates and the firming up of the rentals in 1995 and 1996, the Appellant was able to report a rental profit in 1995 of $72 and in 1996 of $101 and he projected a profit from the rental operation in 1997.

Appellant’s Submissions:

The Appellant submits that he intended from the outset to make a profit. Further, that he had a reasonable expectation of profit based on the rents he thought achievable. He contends further that the expenses claimed were reasonable and were not personal or living expenses except for the amounts conceded by the Appellant of $200.75, $371.96 and $155.57 in 1992, 1993 and 1994 respectively.

Respondent’s Submissions:

The Respondent takes the exact opposite position, namely that there was no reasonable expectation of profit and that the expenses were not reasona ble. There was no further dispute as to personal or living expenses after the Appellant’s concessions described above.

Analysis and Decision:

Both the Appellant and his agent were highly credible. The Appellant did make the errors in claiming a capital amount and the small personal expenses detailed above and admitted same.

For the following principal reasons, I have no doubt that the rental operation carried on by the Appellant in the years in question had a reasonable expectation of profit:

1. The Appellant lived in the basement apartment and rented the remainder of the bungalow. Thus there was a small element of personal involvement. However, it is obvious that he sacrificed his own personal enjoyment by living in the basement and renting out the entire remainder of the bungalow to third parties.

2. It is clear from the pattern of renting operations that whenever the bungalow was vacant the Appellant vigorously tried to find new tenants and was largely successful in doing so. He was very active in marketing the property and advertised on many occasions.

3. The Appellant made certain required improvements to enhance the rental value of the property.

4. The interest rates constantly dropped as set forth above.

5. The Appellant showed a small profit in 1995 and 1996 and projects a further profit in 1997. The Minister did not contest 1990 and 1991 where there were losses of $3,398 and $6,797, but in my opinion, that start up period concession granted by the Minister was not sufficiently long, particularly considering the drop in the rental market that the Appellant experienced and the high interest rates prevailing at the beginning of the rental operation.

6. The Appellant gave an abundantly clear picture of a young person doing his best to make the operation a profitable one. Admittedly, the purchase of the property was highly leveraged but what can one expect from a person whose employment income in 1990 was only $36,000 and whose age at the time of purchase of the property was 30.

7. In my opinion the evidence demonstrates that the rental operation was not in any way a suspicious one designed to create rental losses. In conclusion, for the above reasons the appeals are allowed, provided however, that as accepted by the Appellant the losses shall be as follows:

The matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the foregoing basis.

Appeal allowed.