Leonard – Tax Court of Canada finds that on a foreclosure, the taxpayer disposed of his mortgage, even though the debt it secured remained outstanding

The taxpayer acquired mortgage debt owing by an insolvent developer from the bank at a discount, and then, two years later, purchased the related real estate lot at a judicial auction held pursuant to foreclosure proceedings for a purchase price substantially less than the amount owing under the debt. He was unable to sell the lot.

After finding that the taxpayer had acquired the mortgage debt as part of an adventure in the nature of trade, Sommerfeldt J turned to the question of whether a loss had been realized on the foreclosure process in 2011, given that, as part of those proceedings, the taxpayer received a deficiency judgment for the unpaid amount of the debt (the “Post-Auction Debt”). In concluding that there had been no disposition of the debt, he found that of the “four fundamental terms of a debt obligation, i.e., the identity of the debtor, the principal amount, the amount of interest and the maturity date” identified in General Electric Capital, “the only term that was significantly different in respect of the Post-Auction Debt … was the amount of interest.”

However, Sommerfeldt J nonetheless concluded that the above finding had virtually no impact on his concurrent finding that most of the dollars truly at issue had been realized as a loss as a result of the foreclosure. The key passage appears to be the following:

[S]ubparagraph (b)(i) of the [s. 248(1)] definition of “disposition” … states that “‘disposition’ of any property … includes … any transaction or event by which, … where the property is a … mortgage, … the property is in whole or in part redeemed, acquired or cancelled….” … Thus, by reason of the foreclosure and the judicial sale, the Mortgage was cancelled. By reason of the cancellation of the Mortgage, Mr. Leonard was deemed to have disposed of the Mortgage in 2011.

Accordingly, he appeared to consider that the definition of disposition had the effect of deeming the mortgage security to be a separate property from the debt that it secured.

Sommerfeldt J found, in light of the insolvency of the developer, that it was reasonable to allocate 99.9% and 0.1% of the purchase consideration to the mortgage and the debt, respectively and that “to achieve symmetry” the proceeds should also be allocated in those proportions. Accordingly, the taxpayer sustained a significant loss on his disposition of the mortgage as a result of the foreclosure proceedings, notwithstanding that there was no disposition of the underlying debt.

Summaries of Leonard v. The Queen 2021 TCC 33 under s. 18(1)(b) – capital loss v. loss – debt, s. 248(1) – disposition, s. 171(1), s. 9 – timing, and General Concepts – Evidence.