Kainth v. R., [1997] 3 C.T.C. 2083, 97 D.T.C. 3299

Rip T.C.J.:

1 Chamkaur Kainth has appealed assessments made under the Income Tax Act (“Act”) for income tax for his 1991, 1992, 1993 and 1994 taxation years on the basis that he be permitted to deduct expenses incurred in renting property. The appeals (Informal Procedure) were heard on common evidence.

2 Mr. Kainth is a building inspector employed by the City of Toronto. He immigrated to Canada in November 1988 from India where he had worked for 19 years as a civil engineer managing property and construction sites. With that expertise Mr. Kainth considered that he had the knowledge to manage and rent property in Canada.

3 Mr. Kainth got his first Canadian construction job in April 19, 1989. He stated he “explored Canadian society” and how the rental property was managed in this country and concluded there was a considerable difference between Canada and India.

4 In May 1989, after three months searching, the appellant rented his first apartment for his family in the Jane and Finch area of North York. Rent was $800 per month. The time he spent finding an apartment convinced him there was a shortage of apartments in Toronto.

5 In his Notice of Appeal, Mr. Kainth stated that, “after extensive search, the first of its kind in Canada and guidance from experts” he purchased a property in July 1989 at 194 Mabley Crescent in Thornhill, Ontario (“Mabley property”) for $216,000. In fact, the evidence is that the property was acquired by both Mr. Kainth and his wife, each as to one-half interest. The property was a two-storey home consisting of a basement with three rooms including a small area for cooking and a bathroom and eating area, a main floor of two rooms and a kitchen and a top floor having three rooms. The Mabley property was to be the principal residence for both him and his family. The property was close to York University and Mr. Kainth planned on renting the three rooms in the basement to a “group who liked to live together”. His family would occupy the top floor. He also planned to rent a room on the main floor and share washroom and kitchen facilities with the tenant. He thought he would be able to obtain a fair market rent “without much hassle”.

6 Mr. Kainth stated that he advertised the rooms for rent in The Globe and Mail and The Toronto Star and visited York University to register the property with the off campus rental authorities at the University. He also posted advertisements at convenience stores in the York University area.

7 The appellant said he had a good response to the advertisements. Two students visited the property and “agreed to rent but the rent was not acceptable”. He “tried the same scenario” for two months during July and August but realized that something had happened to real estate since 1989. In 1990 he signed a lease for the basement with some ladies for $800 per month. This lease was to run until April 30, 1991. He originally thought he would be able to obtain $1,000 per month for the basement. He also rented one room on the main floor on a monthly basis for $400; he had projected a rent of $600 for this unit.

8 When he realized the basement tenants were not going to renew their lease Mr. Kainth placed advertisements in The Toronto Sun newspaper. In July 1991, he rented the basement to three people for $800 a month. I was a little confused with Mr. Kainth's evidence at this point: he stated that he rented the basement for one year for an aggregate annual rent of $10,800. However $800 a month multiplied by 12 months equals $9,600. Mr. Kainth then said perhaps the lease was for 13 months, or perhaps the aggregate annual rent was not $10,800. Or, he said, since the tenant paid the first and last months rents in the amount of $1,600, perhaps he got confused. In any event, after two months the tenants had a fight and left. At least one of these tenants was on welfare or had low income and Mr. Kainth did not see any value in pursuing his claim for rent. He tried to get a new tenant.

9 A new tenant was found to rent the basement for $700 a month from October 15 to July 31, 1992, but that person was not willing to renew the lease for $700 once it terminated.

10 In 1993, the appellant rented a room on the second floor of the Mabley property to his daughter.

11 The Mabley property cost Mr. Kainth $216,000. He paid cash of $12,000 and assumed an existing mortgage of approximately $112,000 to $120,000, with an annual interest rate of 11 per cent. Toward the end of 1992 he arranged, “through personal sources”, for a second mortgage of $31,000 and a third mortgage of $15,000, each with an interest rate of 15 per cent per annum. He renegotiated the first mortgage, increasing the loan to $162,000 with an annual interest rate of 13 per cent for a two year term. He explained that the 13 per cent interest rate on the renegotiated amount was derived from a formula that accounted for the interest rate of the original mortgage assumed, 11 per cent, and the market rate at the time the mortgage was renegotiated, which was 17 per cent, together with the principal amounts of the mortgage. Mr. Kainth believed the interest rates would soon decrease. In December 1992 he paid back $46,000 he had previously borrowed.

12 Mr. Kainth stated that he prepared projections for the Mabley property in mid 1990 and foresaw losses for four years. He said he took depreciation into account in making his projections but had no idea what rate of depreciation he used.

13 The losses from the Mabley property continued and Mr. Kainth was getting frustrated. In March 1993 he decided to sell the Mabley property and moved his family to a “rental place of our own”. The Mabley property was sold on April 30, 1993. After the sale Mr. Kainth said he reviewed the problems he suffered with the Mabley property and concluded that the bad experience was due to a poor economy. He decided he could be more successful renting smaller units to individuals rather than large units to groups.

14 The gross income from the Mabley property from 1991 was $6,550. Expenses totalled $19,312.30, the loss was $12,762.31, which Mr. Kainth deducted in computing his income. Mr. Kainth allocated 50 per cent of most expenses to rentals and 50 per cent to personal use. The amount deducted with respect to mortgage interest was $13,609.47 (50 per cent). He also claimed expenses of $2,266.34 for a motor vehicle. His evidence suggested that the automobile was not insured for use in a commercial activity.

15 In 1992 gross income from the Mabley property was $5,250. Total expenses deducted in computing net income were $15,306. Mortgage interest deducted was $8,100. In 1992 the expenses were allocated as to approximately one-third to rentals and two-thirds to personal use. Motor vehicle expenses claimed were $3,116.50 of which $2,716 were deducted in computing income. The net loss from rentals in 1992 was $10,056.

16 All the purported rental losses from the Mabley property were claimed by Mr. Kainth in his income tax returns for 1991 and 1992 notwithstanding he had a one-half interest in the property.

17 In July 1993 the appellant and his spouse purchased a second property located at 196 Elgin Mills Road in Richmond Hill, Ontario (“Elgin property”) for $326,000. The appellant paid $85,000 and the balance was satisfied by way of a mortgage in the amount of $244,500 with interest at 7 per cent per annum. The mortgage was for a six month term, which was renewed as rates decreased. When interest rates started to increase Mr. Kainth “locked into” a longer term mortgage with a 6.75 per cent annual interest rate.

18 The Elgin property was also a two-storey residence. The top floor was occupied by the Kainth family. The main floor included a “unit” for rent and a kitchen to be shared by the family and tenant. The basement contained two units and a bathroom; one unit, consisted of two rooms and an eating area, the other had only one room. Mr. Kainth made efforts to rent the units before closing the transaction of purchase and sale.

19 In June the appellant arranged for a tenant to rent the two-room basement unit for six months, starting July 2, 1993 for $700 per month. His daughter moved into the one room unit on the main floor; she wanted privacy from her family, according to her father. A lease was arranged for the other room in the basement for $700 per month but the tenant did not move to the unit. Advertisements were placed in newspapers to rent units; references were sought, said Mr. Kainth. By August 1994 the basement unit was “finally” rented for 12 months at $650 per month to a “trustworthy” tenant. The tenant gave Mr. Kainth a cheque for $1,000 as a deposit but the cheque “bounced”. The tenant stayed on, paying in “bits and drabs”. Eventually he stopped paying rent. Mr. Kainth was successful in claiming $5,850 against the tenant in Small Claims Court but could not execute judgment.

20 In 1993 Mr. Kainth reported rental income and expenses from both the Mabley and Elgin properties. The gross rental income from the Mabley property was $1,200 and the gross income from the Elgin property was $1,800; all revenue came from his daughter. The total expenses deducted, being the non personal portion of the expenses, from both properties aggregated $18,990. He claimed all of the purported loss of $15,990 in 1993.

21 In 1994 gross income from the Elgin property was $4,950 and total expenses from the property, after allocation for personal use, aggregated $19,525.23. Mrs. Kainth apparently reported losses of $4,809.93 and Mr. Kainth claimed losses of $9,765.30 for 1994.

22 Units in the Elgin property were rented in 1995 and 1996 and Mr. Kainth reported a profit from rentals in those years.

23 Mr. Kainth acknowledged that he did not take capital cost allowance with respect to either the Mabley or Elgin properties. His reason for not doing so was that he wanted the properties to qualify as his principal residence and, based on literature he read, deducting capital cost allowance with respect to these properties would taint the character of the properties.

24 The Mabley property was not a property from which Mr. and Mrs. Kainth could reasonably have anticipated a profit at time of acquisition. They purchased the property primarily as a place in which to live and rented part of the house to assist in paying for the property. The property was heavily mortgaged. There was no evidence to establish that if Mr. and Mrs. Kainth had rented the units at a reasonable rent in the circumstances the Mabley property could have generated at least the interest payable on the mortgages.

25 The majority of the spaces available for rent at the Mabley property was never rented for any extended period. In 1991 and 1992 Mr. Kainth and his family lived on the top and main floors of the Mabley property. In 1991 the tenants lived on the property from July 16 to August 31 and from October 15 to December 31, a period of four months. Only the basement was rented; the main floor unit was vacant. In 1992 the main floor unit was rented for four months and two tenants lived in the basement. In 1993 the only tenant on the Mabley property was the appellant's daughter. The situation was deteriorating and the appellant sold the property.

26 Mr. Kainth conceded that when he purchased the Mabley property he was “ignorant of Canadian society”. His experience with that property indicates that when he purchased the property he had no idea what his prospects were. The expenses with respect to the Mabley property were not incurred with a reasonable expectation of profit.

27 Mr. Kainth appears to have learned from his experiences with the Mabley property. He was now aware of what units would be rentable and what was required to rent the units in Toronto. When he purchased the Elgin property, there were rentable units in the building. He knew who would be attracted to these units. The property now has a positive cash flow, if not a profit. Indeed, respondent's counsel conceded the appellant may have had a reasonable expectation of profit from the Elgin property and I agree.

28 The appellant's expenses with respect to the Elgin property, however, were less than that claimed. I am not satisfied that the bulk of his automobile related expenses were incurred for the purpose of obtaining rental income, and in any event these expenses were not reasonable bearing in mind the amount of rent received and the number of tenants at any particular time. I would increase the personal use portion of the automobile expenses to 70 per cent. I would also allocate the rental expenses as to one-half to each of Mr. Kainth and Mrs. Kainth.

29 It is on this basis that I would allow the appeals for the 1993 and 1994 taxation years. The appeals for the 1991 and 1992 taxation years will be dismissed. There will be no order for costs.