Date: 19990520
Docket: 98-478-IT-I
BETWEEN:
MARY LOUISE STEPHENS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
BOWIE J.T.C.C.
[1] The Appellant was reassessed for income tax for the 1992
and 1993 taxation years, to disallow her claim that she is
entitled to take her very substantial losses from a rental
property into account in computing her income for those years
under section 3 of the Income Tax Act (the Act).
She takes the position that her house at 417 Mortimer Avenue,
East York, (the Mortimer house) was a source of income, and that
its losses should be included in the computation of income. She
has appealed from these reassessments. The Minister of National
Revenue (the Minister) takes the position that for the years
under appeal she had no reasonable expectation of profit from
that house, and that it was therefore not a source of income, and
so its losses may not be taken into account.
[2] The law in this area is well settled. I must examine all
of the facts disclosed by the evidence, and apply the criteria
which have been established by which to determine whether or not
there was a reasonable expectation of profit. If there was, then
the Appellant is entitled to succeed. If there was not, then her
appeals must fail. The Attorney General has pleaded in the Reply
that the Appellant's expenses in connection with the property
were unreasonable, and that they, or at least some of them,
should therefore be disallowed under section 67 of the
Act. It does not appear, however, that the Minister's
assessor has troubled to make any analysis of the expenses as to
their reasonableness. Nor are any particular expenses singled out
in the Reply as being unreasonable.
[3] The Appellant inherited a seven-bedroom house on seven
acres of land in Port Bruce in 1984. She rented it out from 1985
to 1989, at which time she sold it, because it was too far from
her residence in Toronto, so that looking after it was difficult
for her. She then looked for a rental property to buy in
metropolitan Toronto, where she lives.
[4] The property which she purchased was the Mortimer house.
It is a bungalow, which was said in the real estate listing to
have two rooms in the basement. Under some pressure from a real
estate agent, she bought this house without seeing the basement,
with the intention, she said, of renting the main floor and the
basement to separate tenants. She was surprised and disappointed,
after taking possession, to discover that the two rooms she had
been told were in the basement in fact consisted of one large
room with a partial divider. The basement was not suitable for
rental as a separate unit, and in fact she discovered, also after
the purchase, that it would be contrary to the applicable by-law
to rent the house as two separate units.
[5] By the time that the Appellant discovered these
difficulties she had purchased the house, and she felt that she
had little alternative but to make the best of her situation. She
therefore rented the main floor, which had two bedrooms, for $890
per month. If I understood correctly, the basement remained empty
initially, producing no income. During this period she and
another person were living in a house elsewhere in the city, and
sharing the rent. After about two years she decided to move into
the basement of the Mortimer house, thereby saving herself the
cost of paying rent elsewhere.
[6] The Appellant paid $209,000 for the Mortimer house. She
paid $50,000 down, and the balance of $159,000 was financed by
three mortgages. She was unsure of the interest rates payable on
these, but the lowest seems to have been 10%. Her monthly
interest payments for the mortgages alone amounted to at least
$1,650 per month at the outset. She gave several different
amounts during her evidence which she said were her expected
monthly income, had she been able to carry out her original plan
to rent the main floor and the basement as separate units. These
ranged from a high of $2,000 to a low of about $1,550. None of
these estimates seemed to be derived from a realistic view of the
rental market in the neighbourhood. I do not believe that she had
any knowledge of the rental market there, nor did she give
evidence of having made any inquiries.
[7] It was suggested to me in argument that this is a case
which should be viewed as one involving personal use by the
taxpayer of the property, because by the time of the years under
appeal she had moved into the basement of the house. She did this
in an attempt to minimize her losses, however, and in my view it
is appropriate to assess the reasonableness of her expectations
on the basis that the house was, from the start, intended by her
to be an investment. It must be assessed objectively, however. It
is not sufficient for the Appellant to say, as she did, that it
was her intention to rent the house at a profit for a period of
time, and then sell it and buy a more expensive one, and continue
in this pattern in order to acquire more and more valuable
properties, and so provide herself with a retirement income.
[8] Turning to the criteria by which I must measure the
prospect of profit, the most important one in the context of a
rental property is the ability of the property, as financed, to
produce a profit. Also important in the context of a rental
property is the Appellant's planning, both at the outset and
after the inability to produce a profit has appeared. It is well
established that the courts should not be quick to second guess
the business decisions of the Appellant, and that errors in
judgment and unforeseen events causing losses should not lead
inevitably to the conclusion that the taxpayer's rental
property was not a source of income.
[9] In my view the Mortimer house, as financed by the
Appellant at the time that she purchased it, never had the
potential to produce profit as a rental property. It is true that
she encountered some unexpected difficulties. Soon after she
bought it she seems to have found herself faced with bills for
some major repair and alteration work. She said in evidence, that
in addition to the purchase price, she spent more than $20,000 on
various items. She was not able to give any detailed account of
what they were, but I accept that there were many things that
needed to be repaired, and that she also spent a considerable
amount in trying to make the basement into a rentable apartment.
She also managed to pay off the third mortgage from an
inheritance, but it is not clear to me whether she knew at the
outset that these funds would become available to her, or if it
was simply a windfall.
[10] Two things are clear, however. First, the Appellant made
no proper investigation of either the house itself, or the real
estate rental market in the neighbourhood before she purchased
the property. If she had she would have seen immediately that
this house, purchased on the terms that she agreed to, could not
possibly produce a profit. Second, the Appellant learned very
quickly after she acquired the house that it could not be
operated at a profit. As soon as she learned that the basement
had no income potential she must have realized that the income
would not be sufficient to cover the expenses. By this time house
prices were on the decline, and she was reluctant to sell at a
loss. As a result she operated at an annual loss for the next
several years. The net losses from this property during the seven
year period from 1989 to 1995 were:
1989 $ 9,819
1990 $ 7,470
1991 $13,937
1992 $19,608
1993 $10,454
1994 $ 3,568
1995 $12,301
[11] In 1993 the interest expense alone attributable to the
rental portion of the house was about one and one-half times the
gross rental income. This appears to have been true of the years
from 1989 to 1991 as well. In spite of these unrelenting losses,
and her inability to do anything that would stem the tide, the
Appellant apparently made no effort to sell the Mortimer house
until 1998.
[12] This continuous history of losses is only one of the
criteria to be applied by me in deciding whether this property is
a source of income. I have considered the other criteria set out
by the Federal Court of Appeal in Landry v. The Queen,[1] and I find that
the Appellant did not have the degree of either training or
experience which would enable her to turn this history of loss
into a future of profit. So far as I can tell from the evidence
before me, she did not adjust to the situation, or develop a plan
to deal with it.
[13] The Appellant's agent likened this case to
Costello v. The Queen.[2] However, in that case Judge Bowman found that
the Appellant had gone about finding an investment property in a
rational and businesslike way, and that her projections of income
and expense were reasonable. Some unforeseen events, which were
similar to some of those which befell Ms. Stephens, frustrated
her immediate expectations. Nevertheless, the Appellant in that
case, unlike Ms. Stephens, took corrective action, and by the
time of the hearing she had brought the property back to
profitability. In the present case, the most recent years for
which I have evidence were not profitable, nor was I shown any
course of action that might remedy that.
[14] In my opinion, even making generous allowance for the
Appellant's misfortunes, and her poor judgment, and for the
deceit that she says was practiced on her by those selling the
property, there was not even a slight possibility, far less a
reasonable expectation, in 1992 and 1993 that this property could
produce a profit for the Appellant.
[15] The appeals are dismissed.
Signed at Ottawa, Canada, this 20th day of May, 1999.
"E.A. Bowie"
J.T.C.C.
Email this Content