Date: 19991105
Docket: 98-957(IT)I
BETWEEN:
HUBERT H. YAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
AND
98-961(IT)I
IRENE M. YAU
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Taylor, D.J.T.C.C.
[1] These are appeals heard on common
evidence in Toronto, Ontario, on October 19, 1999, against
assessments under the Income Tax Act (the
"Act") in which the Respondent had disallowed
certain amounts claimed by the Appellants as "rental
losses".
[2] I reproduce the Notice of Appeal
of Hubert H. Yau, which is identical in all relevant respects to
that of Irene M. Yau. Both Appellants gave testimony and in
general it followed the information provided in this Notice of
Appeal.
"REASONS FOR THE APPEAL
The issue to be decided is whether the Appellant's
expenditures in relation to the property and claimed as rental
losses were incurred by him for the purpose of gaining or
producing income.
The Appellant submits that at all material times the
expenditures in relations to the property were incurred by him
for the purpose of gaining or producing income.
The Appellant had a reasonable expectation of profit when
purchasing the property, and has continued to act reasonably so
as to earn income.
FACTS IN SUPPORT OF THE APPEAL
On or around July 22, 1987, the Appellant, jointly with his
spouse, Irene M. Yau, acquired a property municipally known as
18165 Lakeworth Boulevard, Port Charlotte, Florida ("the
property") from the vendor, Port Charlotte Homebuilders Inc.
The Appellant purchased the property with the purpose of earning
rental income.
The property is a free standing home with a swimming pool. It
is soundly constructed and is located in an attractive
subdivision.
Prior to purchasing the property, the Appellant attended
financial planning seminars and discussed the merits of owning
rental property in Florida with other property owners. The
Appellant was advised that the purchase of a property for rental
in Florida was a sound investment and one from which he would
realize a profit.
Prior to purchasing the property, the Appellant was advised by
an agent of Port Charlotte Homebuilders that he could expect the
property to be rented at least 60% of the time. The Appellant was
further advised that Port Charlotte Homebuilders would advertise
the availability of the property for rental and would manage the
property on a day-to-day basis.
The purchase price for the property was $98,725.98 USD. The
Appellant also purchased furnishings for the property directly
from Port Charlotte Homebuilders at the cost of approximately
$10,000.00 USD.
The Appellant provided a down payment of $6,400.00 USD and
financed the balance of the purchase price through a line of
credit. The interest rate for the line of credit increased from
1987 to 1990.
The property was first rented in March, 1988 and continues to
be available for rental. The rental occupancy rates through to
1995 are as follows:
|
YEAR
|
OCCUPANCY RATE (%)
|
|
1988
|
70
|
|
1989
|
52
|
|
1990
|
39
|
|
1991
|
44
|
|
1992
|
39
|
|
1993
|
21
|
|
1994
|
27
|
|
1995
|
17
|
The Appellant took steps to increase the profitability of the
property steps include but are not limited to the following:
(a) In 1990, the
Appellant mortgaged his property in Mississauga and reduced the
indebtedness on the line of credit, thereby reducing the
financing charges associated with the property;
(b) In 1992, the
Appellant borrowed $10,000.00 from his father and $6,500.00 from
his children at lower interest rates, thereby further reducing
the financing charged associated with the property;
(c) In 1995, the
Appellant retained Florida Home Finders to act as his rental
agent, at a lower fee than that charged by Port Charlotte
Homebuilders. In 1996, the Appellant retained Southern Sands Inc.
As his rental agent, at a lower fee than that charged by both
Florida Home Finders and Port Charlotte Homebuilders.
The Appellant submits that he has acted reasonably and had a
reasonable expectation of profit from the property."
[3] In response thereto the Respondent
filed the Reply to the Notice of Appeal which stated among other
comments:
(b) the disallowed
rental losses were claimed in respect of Lakeworth, a Florida
bungalow purchased by the Appellant and Irene M. Yau, (the
"Appellant's spouse"), in 1987;
(c) in each and
every taxation year since 1987, the Appellant has claimed a
rental loss;
(d) the Appellant
reported gross income, expenses and net losses from Lakeworth in
the 1992, 1993, 1994 and 1995 taxation years as follows:
TAXATION
GROSS
NET
YEAR
INCOME
EXPENSES
LOSS
1992
$12,714.49
$25,410.20 *$12,695.71
1993
$
9,823.93
$23,150.31 *$13,326.38
1994
$
9,661.01
$23,105.80 *$13,444.79
1995
$
6,998.64
$23,658.85 *$16,660.21
*The total net loss reported in respect of Lakeworth was split
between the Appellant and his spouse, 40% of the total net loss
reported was claimed by the Appellant's spouse and the
remaining 60% was claimed by the Appellant;
(e) the claimed
expenses of Lakeworth were personal or living
expenses of the
Appellant;
(f) the
Appellant did not have a reasonable expectation of profit from
Lakeworth in the 1994
or 1995 taxation years."
[4] In addition to the information in
the Notice of Appeal, the Appellants emphasized certain other
aspects of the situation which they regarded as significant -
that in 1986 they paid off the mortgage on their residence and
looked for some investment opportunities with the funds each
month which would now be available. As a result of some serious
investigations, consultations and advice, including such advice
from those whom they understood to be knowledgeable in income tax
and real estate matters, they flew to Florida and inspected the
subject property. As they saw it, the construction was sound, the
down payment was within their means, and the monthly costs
allowing for the rental, which purportedly would be expected,
would be manageable and within a few years, according to their
calculations, produce a profit. Among the points cited by the
Appellants which adversely affected these projections were -
increased mortgage interest rates earlier in this period,
difficulties with rentals not remaining at the early levels and
the construction of additional homes (finally about 250) in the
development, many of which were also available for rent. In
addition they found that costs of operating and particularly
maintenance were quite high, and in an effort to minimize this,
they tried to do much of the work themselves. Counsel for the
Respondent, in cross-examination, brought out in addition to
several other salient points, that a major part of the financing
difficulty arose because the Appellants had opted at the start
for a form of Line of Credit financing from their Canadian bank,
rather than a standard fixed term mortgage, and that left them at
the mercy of fluctuating interest rates. Security for the bank
financing had been arranged using their now mortgage free
Canadian residence. While arguing that they had hoped to retire
in Florida in maybe 20 years from the date of the purchase of the
property, they contended that would only have been when it was
paid off or at least easily managed. They had changed Florida
management companies, and while they still owed some $190,000.00
Canadian on the Property, the new management was doing better in
their opinion.
[5] In argument, counsel for the
Appellants stressed that they had carefully examined the
investment and the prospects they saw, before entering into the
arrangement. During the course of the years that followed, up to
the present, they had consistently taken steps to minimize their
losses and strived toward making a profit.
[6] Counsel for the Respondent
stressed the early losses would not be overcome by the best
efforts of the Appellants, and that the proposition, financed as
it was, far from their own location in Canada which required on
site management, and their own lack of experience and knowledge
about the real estate business virtually doomed it to failure
from the start. Further, the Respondent had allowed the losses
for some seven years.
[7] Both counsel referred to some
recent relevant case law in particular, Cheesmond v. R.,
[1995] 2 C.T.C. 2567, 95 D.T.C. 4022, Tonn et al. v. R.
[1996] 1 C.T.C. 205, 96 DTC 6001, Green v. R., [1997]
1 C.T.C. 2668, Mastri v. R., 216 N.R. 74, 97 DTC
5420, Mohammad v. R., 97 DTC 5503, [1997] 3 C.T.C.
321.
CONCLUSION
[8] In my view the issue was correctly
summarized by counsel for the Respondent. I would particularly
note the case of Cheesmond (supra) which dealt with
a similar situation in precisely the same development. That
appeal was dismissed by the learned Judge Bowman of this Court
and with that I certainly agree. However, I would place the
emphasis in these appeals on the issue raised by the Respondent
"reasonable expectation of profit" rather than that
stressed in Cheesmond - section 67 and paragraph
20(1)(c) of the Income Tax Act; and the 100%
financing factor. These points were examined in a very recent
judgment of the Supreme Court of Canada in Shell Canada
Limited and Her Majesty the Queen, file no. 26596, dated
October 15, 1999.
[9] I would also quote from
Mastri (supra):
"The Tax Court Judge having erred in his application of
Tonn, and in light of the fact that his finding of lack of
reasonable expectation of profit has not been challenged, the
taxpayers are not entitled to deduct their respective shares of
the rental loss from other income sources."
[10] The Appellants cannot claim that the
issue of "reasonable expectation of profit" in tax
matters is only of recent vintage and it is regrettable that
those from whom they sought advice prior to the purchase did not
see fit to steer them to case law which was readily available,
relevant and instructive on that critical point. The
Respondent's permissive attitude in the years prior to 1994
in this matter might well be categorized as generous in the
extreme but perhaps it served to imbue the Appellants with a
false sense of satisfaction and security about the unprofitable
results.
[11] The appeals are dismissed.
Signed at Ottawa, Canada, this 5th day of November 1999.
D.J.T.C.C.
Email this Content