Perovic v. R., [1997] 1 CTC 2566, 96 DTC 3257 (Informal Procedure)

Taylor J.T.C.C.: — This is an appeal heard in Toronto, Ontario on October 7, 1996, against assessments in which the Respondent had disallowed rental losses claimed in the amounts of $10,113, $14,996 and $14,504 for the years 1991, 1992 and 1993. I quote the following from the Notice of Appeal:

In this case, I truly thought that I could earn a profit on the rental of the property. However, I realized that the operation would not be profitable immediately. I was willing to wait. Eventually, as a result of increased rents and decreased interest costs, I felt confident that the operation would become profitable. Unfortunately, I overestimated the amount of rental income that could be earned by the property in the early years. The amount estimated was based on an existing rental property on the same street. The actual rent received is not what was expected. I should not be penalized for this error in judgment. Please remember that I intended to hold and operate the property for a substantial period of time and that he [sic] was willing to withstand the losses during the initial start up. Rest assured that I did not invest $226,000 in the property, in order to lose almost $30,000 in the first two years. This was a property which was to be held for some period of time, as I realized that profitability would take some time.

In the Reply to Notice of Appeal, the Respondent commented on the circumstances:

In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) the Appellant purchased a two bedroom bungalow at 224 Glenwood Crescent, Toronto, Ontario (the “Property”) in June of 1991 as a personal residence;

(b) beginning in June 1991, the Appellant rented different floors of the Property, reporting the rental portion of the total expenses of the Property to be 100% for 1991 and 75% for each of 1992 and 1993;

(c) from 1991 to 1993, the Appellant reported rental income, expenses and losses from the Property as follows:

YEAR INCOME		INTEREST EXPENSE	TOTAL EXPENSE	LOSS
1991	$2,300	$ 7,722	$12,913	$10,113
1992	$6,600	$14,450	$21,596	$14,996
1993	$7,100	$14,814	$21,604	$14,504

(d) in the 1994 taxation year the Appellant also reported a rental loss from the Property in the amount of $8,159;

(e) the rental income received by the Appellant in the 1991, 1992 and 1993 taxation years did not cover the interest expense alone;

As I understand the testimony, the Appellant did not pursue his original intention of using the property as a “principal residence”, because of a change in his marital status. However, he lived in the building (a two bedroom bungalow), from time to time during 1991 and 1992, and finally in 1993 occupied the major portion himself. For a time it had also been rented to his brother, while he made efforts to rent it, particularly the renovated basement area, but with little success. A main factor I considered however was the questionnaire he had completed for Revenue Canada, particularly that the property had been purchased as a “principal residence”, and there is no evidence to support his assertions that this statement was just in error and that his purpose had always been a “commercial enterprise”. The rent he did receive which he alleges was at the going rate for the area, was never enough to carry even a modest portion of the total costs of the property let alone an appropriate portion, particularly when the financing charges are considered. Whatever may have been the Appellant’s original intention for the property, it appears to me that it became a partial rental property more by circumstance than design by him.

A reference could be made for comparison purposes, to the recent case of Mastri v. R., [1996] 3 C.T.C. 2702 (T.C.C.) which was allowed, but is now under appeal to the Federal Court by the Minister of National Revenue. In that case the Appellants had also purchased a house, with the intention of using it as a primary residence. Due to the circumstances recited in the judgment that did not develop, the Appellants did not move in the house at all during the year under appeal - but rented it, albeit at a loss. That is at least somewhat different than this appeal of Mr. Perovic. I would also add this is not a fitting situation in which to apply even loosely constructed standards for “start-up costs”, as I understand them. Start-up costs as outlined in the case law may have some merit in certain circumstances, but the rationale does not seem viable to me to be invoked for each and every loss sustained, when it can reasonably be pre-determined that there should not be, perhaps never could be an expectation of profit.

Before closing I would make reference to a comment in Joseph v. R., [1996] 2 C.T.C. 2388 by the Tax Court of Canada, at pages 2397-98 which might eventually have some application in this matter:

Two statements from Mrs. Joseph’s Notice of Appeal (supra) are of specific interest:

5. When the Business makes money Revenue Canada will claim its share as it always does.

6. I deem it unfair that which [sic] I make a loss, Revenue Canada refuses to accept my business as valid and bona fide.

Whether it was in her mind I do not know, but it raises the intriguing prospect of using the provisions of section 111 of the Act, part of which reads:

Losses deductible

(1) For the purpose of computing the taxable income of a taxpayer for a

taxation year there may be deducted such portion as he may claim of -

(a) non-capital losses - his non- capital losses for the taxation years immediately preceding and the 3 taxation years immediately following the year;

I can appreciate that in her understandable zeal to utilize to the fullest extent the more immediate deduction provisions in the Act, this taxpayer might have tended to reject consideration of the above provision. Whether she could claim such “loss” deductions (even if initially denied by Revenue Canada) against profits actually realized later on, which profits would then help to prove her claim of the viability of the questioned venture would require examination. Such a practice might even lend itself to an added incentive for earlier profit production from such a venture, or conversely acceptance of the reality that the financial results demonstrated. A small ultimate profit in one year, still might not be adequate to overturn years of losses - to make a “source of income” - but I need make no determination of that point at this time. It might also be argued that the provisions of Section III above were inserted in the Act for the express purpose of providing a reliable and useful route for recording, even possibly reporting, but not immediately deducting, early or “start-up” losses incurred, as opposed to the more contentious “front-end loading” avenue frequently pursued.

The appeal is dismissed.

Appeal dismissed.