Michel-Guy Huot v. Minister of National Revenue, [1990] 2 CTC 2364

Garon, T.C.J. [Translation] :—The issue in these appeals relates to the right to the deduction of rental losses claimed by the appellant in computing his income for the 1982, 1983 and 1984 taxation years.

In his reassessments for these three taxation years, dated July 22, 1986, the respondent refused these expenses on the grounds that they were not made or incurred for the purpose of earning income, related to properties that were not kept for the purpose or with a reasonable expectation of profit and constituted personal or living expenses within the meaning of subsection 248(1) of the Income Tax Act, the deduction of which is prohibited by paragraph 18(1)(h) of the Act.

The facts are relatively simple.

On December 23, 1980 the appellant acquired from his mother a property located in the municipality of Boischatel not far from Quebec City, consisting of a main house with eleven rooms and two cottages as well as “all the furniture, fittings and household appliances located there”, with a few exceptions. The furnishings in the main house were of little value, according to the evidence. There was also an in-ground swimming pool on this property. The total area of the lot was 101,525 square feet, according to the contract. The purchase price of this property was set at $40,400. The market value of the property was estimated by the parties in the deed of sale at $76,400. The statement of the market value of this property was required by the Act authorizing municipalities to collect a tax on real estate transfers under this contract, the appellant, who was referred to in the deed as the assignee, gave an undertaking that read in part as follows:

[Translation]

. . . to leave to the assignor and to her husband named hereinafter for their lives or as long as the state of their health does not, in the view of a qualified medical practitioner, require their placement in an institution, the occupation and enjoyment of the aforementioned property, including the land and buildings, with the fittings, furnishings and all appliances located there.

The value of this right of residence was estimated by the parties to the contract at $36,000. This statement was also required by the above-mentioned act relating to the collection of certain taxes on real estate transfers. The contract also provided that:

. . . the assignee shall be exclusively responsible for all charges relating to the preservation of the said property, messuage and tenements, and those relating to property, municipal and school taxes and other public charges, heating and hydro,

The same clause also provided:

. . . the assignor or her husband undertake to pay by way of compensation a monthly sum of Two Hundred and Fifty Dollars ($250) per month from the first day of January next (1981), as long as the assignee is not able to enjoy the said property.

The contract even contained a provision that the appellant did not have "the right to sell, alienate and mortgage without the authorization” of his mother and father "as long as they are living”.

The monthly payment of $250 was increased to $350 some time in 1986. The appellant also testified that he received a total of $6,000 from his parents in 1986 and $6,240 in each of 1987 and 1988. These amounts of $6,000 and $6,240 included the monthly payment of $350 and a supplement in the form of a special payment for the difference.

The purchase of this property by the appellant was made possible by a mortgage of $35,000 contracted for a period of 20 years at a rate of 16 per cent to begin with.

A document filed as Exhibit A-1 showed the expenditures and income relating to this property for the years 1981 to 1988 inclusive. It is reproduced below:

This statement shows losses for the first five years, which amounted to $7,460.64 for 1981, $9,746.09 for 1982, $7,987.04 for 1983, $11,152.46 for 1984 and $5,637 for 1985, and small profits for 1986, 1987 and 1988 of $192.40, $257.72 and $725.18 respectively. I should also note that in this statement of income and expenditure the appellant did not claim a deduction of any amount for capital cost allowance in respect of the depreciable property consisting of the main house, the cottages and the furniture. The appellant had the option of reducing his profit for 1986, 1987 and 1988 to zero by claiming, as he was entitled to do, a deduction for depreciation equal to his profits.

The appellant also stated that the rent charged to summer visitors for the cottages was increased gradually over the years. These cottages were leased each year for only a maximum period of five months. He explained that when he became the owner of this property, he did not wish to make substantial increases in the rents, the amounts of which were clearly below the rental value. There was no break-down of the various items of expenditure between the house and the cottages. The appellant claimed that he was unable to provide any and his explanations seemed valid to me. It is accordingly not possible to say whether the rental of the cottages, considered separately, was a profitable operation and, if so, to determine the point at which it became profitable. The property in question must therefore be considered as a whole; it is impossible to break it down into its various components.

The evidence also established that the house had been built in about 1903 and the cottages between 1920 and 1925. They were old buildings. The table to which we referred earlier also shows that substantial expenditures were in- curred during 1984 as a result of damage sustained during the winter. In fact, expenditures rose to almost $7,000, whereas in the preceding year, 1983, and in the following year, 1985, expenditures were a little under $2,000. In addition, the heating system was converted; the house is now heated with electricity and is better insulated. The house was reroofed and substantial repairs were made to a supporting wall. It was also for 1984 that the appellant made the greatest loss, approximately $11,000. Moreover, I should note that the expenses in the form of interest on the mortgage contracted by the appellant fell by about one-half over a seven-year period, from $5,284.56 in 1981 to $2,839.34 in 1988.

The appellant admitted without hesitation that the monthly payment provided for in the contract was well below the rental value of the main house. He also indicated that the maintenance expenses of the house were greater than he had originally anticipated.

When he purchased this house, the appellant's mother had just undergone major surgery. It was her second operation for cancer. The appellant's brother, Jacques Huot, stated the following in his testimony concerning his father's physical condition when this property was purchased: ”. . . the state of health of my father, who, all the same, had earlier, at that time, left something to be desired with respect to his legs in any case."

When this property was purchased by the appellant, his father was a few weeks away from his 72nd birthday and his mother was 65 years old. The appellant was convinced that he would make a profit from the rental of this property after his parents left. The appellant's brother, Jacques Huot, who has a great deal of experience in real estate, was in complete agreement in his testimony. At the time this property was purchased, it was not possible to foresee the day when his parents would no longer live in this house. In fact, when this appeal was heard they were still living there.

On examination as to his intentions when he acquired this property, the appellant was not particularly clear. He stated the following:

Q. Did you wish to retain this property in your family?

A. No. I purchased it because. . .Saying to myself that, eventually, my parents,. . .they were old at the time, well, they would not be there forever and I could sell this property after a while.

Later during the hearing I attempted to make him explain his intentions when I asked the following question:

The Court:

But under your oath, then, at the time of the purchase you knew that your parents would live there for a certain, "X" length of time that no one knew in advance, but after your parents left, did you want to sell it immediately after?

The Appellant:

It is not my intention. I do not believe that, at the time when I purchased that property, I could say: “My parents will die; well, I shall sell it.” And it is a house with its cottages that can be leased out and, well, who can foretell what will happen? What exactly was my intention? I certainly could not see myself saying: "My parents will die or leave and I shall sell the house". That's not how it is done. I bought it. Then with a hope of earning income from it.

Then, the day when they are no longer there, well, what will happen? It will be leased. . .possibly, if the management of a house is too complicated, I shall sell it. But all kinds of things are possible. It is impossible to tell ahead of time.

It must accordingly be determined whether the appellant could have had a reasonable expectation of profit from the leasing of this property in the relevant years. We must therefore isolate the most important elements from the evidence and draw the appropriate conclusions.

First, it seems quite clear to me that, as soon as the appellant's parents left the main house, the leasing of this property could easily become profitable. This emerges particularly from the fact that the appellant was able to record slim profits in 1986, 1987 and 1988 when his parents were paying approximately $6,000 per year, although a monthly rent of between $800 and $900 would have been reasonable for the main house or, at least, would be so at the present time, according to the testimony of Jacques Huot. Admittedly, these profits do not take into account the deduction for depreciation that could have been claimed with respect to the depreciable property and that could have absorbed this small amount of income in its entirety. Thus, we are not dealing with a type of property that is not likely to be profitable or that could only be so under extremely favourable circumstances. If the appellant's parents had, for example, left the house in the months following its purchase, it may be concluded that the property could have been leased at a profit in the very short term say three or four years, given a reasonable deduction for depreciation of the eligible property. However, the question arises as to whether it was realistic for the appellant when he purchased this property to believe that his parents would live there for only a few years.

As was stressed by the appellant's brother, there is a large element of uncertainty. He compared this situation to the risk assessments made by insurance companies. On this point I am forced to conclude that the appellant could reasonably have believed, given the state of his mother's health and the age of his father, that it was likely that his parents would live in this house for only a limited number of years. Thus, when the contract was concluded on December 23, 1980, there was a possibility that the parents would live there for only a few months just as it was not impossible that they would live there for fifteen years or so. This eventuality, which depended on the time when the appellant's parents left the main house, was very difficult to assess and created a problem as to when the property as a whole would be able to produce an income.

The monthly payment of $250, which was to be paid to the appellant in respect of their occupation of the property is another factor that must be considered. The evidence is clear that this payment was well below the rental value of the main house. The amount of this payment must be considered in light of two factors. The first is that the amount of this obligation must be related to the cost of acquisition, which was also substantially below the market value, according to the evidence. This price, which was advantageous from the appellant's viewpoint, had, in its turn, an impact on the profitability of leasing the house and the property as a whole in the instant case, given the method of financing adopted by the appellant. In this case, in fact, the mortgage used to finance the purchase of the house covered approximately 85 per cent of the purchase price. If we assume mortgage financing of an amount corresponding to the same proportion of the market value of the property, this means that the interest costs would almost have doubled if the appellant had purchased this property at market value, which, as was noted earlier, was set in the contract at $76,400. The fact remains that the size of this monthly payment was an important negative factor with respect to the profitability of this property in the years in question.

Concerning the second factor relating to this monthly payment, it was shown that it was increased from the $250 it had been in 1981 to $350 in 1986 and added to this was an annual supplement of approximately $2,000 for each of 1986, 1987 and 1988. In each of these latter three years, the appellant accordingly received the equivalent of a rent of almost $500 per month. The sale contract for this property dated December 23, 1980 did not provide for adjustments to this payment. However, the appellant noted in his testimony that even prior to 1986, the year in which the amount paid to the appellant by his parents doubled over that paid in previous years, his parents had said that they would agree to an adjustment being made.

On the basis of the evidence, it does not seem unreasonable to me to find that, when the appellant purchased this property, he could reasonably expect periodic adjustments to this payment, although the total amount thereof would always be considerably below the rental value of this house. In short, I consider this clause in the contract governing the payment to be a major negative factor, although it is moderated or alleviated to some extent only by the reduced financing costs resulting from the relatively low purchase price and the genuine possibility of adjustment to this payment.

In examining the question of the profitability of this property, we must take into account the fact that the buildings in question on the property are old. As has already been stated, substantial repairs greater than had been anticipated have already been made to the house and the evidence showed that it is now in better condition. This assertion is supported by the fact that maintenance costs have fallen substantially in the last three years, amounting in each case to less than $1,000, but the fact remains that it is realistic to anticipate fairly large maintenance costs for the property as a whole in the coming years.

In analyzing this evidence as a whole, I must bear in mind the rule of law stated by Strayer, J. in Clifford Meech v. The Queen, [1987] 1 C.T.C. 421; 87 D.T.C. 5251, in the following passage at page 423 (D.T.C. 5252):

The essential question appears to be whether these losses can be attributed to expenses within the meaning of paragraph 18(1)(a) of the Income Tax Act. That paragraph provides, to the general rule against deductions from the income of a taxpayer from a property, an exception with respect to

an outlay or expense. . .to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the. . .property;

This has been taken to mean that for an expense to be considered to have been made for the purpose of gaining income from a property there must be some reasonable expectation of profit from that property. See, e.g., Cecato v. M.N.R., [1984] C.T.C. 2125; 84 D.T.C. 1110 (T.C.C.). With respect to the meaning of reasonable expectation of profit, it was said by Dickson, J. in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 (S.C.C.), at 313-14 (D.T.C. 485-86):

. . . In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.

The objective nature of this test has been illustrated in many cases such as Lorentz v. M.N.R., [1985] 1 C.T.C. 2144; 85 D.T.C. 131 (T.C.C.); Arbus v. M.N.R., [1980] C.T.C. 2872; 80 D.T.C. 1744 (T.R.B.); Paikin v. M.N.R., [1987] 1 C.T.C. 2041; 87 D.T.C. 6 (T.C.C.); and Saleem v. M.N.R., [1984] C.T.C. 2660; 84 D.T.C. 1579 (T.C.C.).

On the basis of all the evidence, I have concluded that the appellant did not succeed in establishing that the rental expenses were made or incurred in the taxation years in question for the purpose of earning income. The appellant did not show that he realistically had a reasonable expectation of being able to lease this property at a profit. There were simply too many uncertainties. The monthly payment owed by his parents while they lived in the main house was well below the rental value of this residence. This was a major negative factor that was compensated for only in part by an advantageous purchase price and the possibility of a partial adjustment, also uncertain, as long as the parents lived in this property.

The departure of the appellant's parents from the main house on the property was another important unknown that affected the profitability of this property for rental purposes. Moreover, the appellant was rather ambivalent as to his intentions concerning the sale or rental of this property when his parents ceased to live there. In fact, he did not establish, as he was required to do, that his well-defined intention, both when he purchased this property and during the years in question, was to lease it at a profit after his parents left and not to sell it.

For these reasons I dismiss the appeal.

Appeal dismissed.