Mervin L. Riddell v. Her Majesty the Queen, [1996] 3 CTC 2869, 97 DTC 51

Bowman J.T.C.C.: — These appeals are from assessments for the 1989, 1990 and 1991 taxation years. They involve the deductibility of losses sustained by the appellant in respect of a single family dwelling in Tucson, Arizona. The principal basis of disallowance of the losses was that the rental operation had “no reasonable expectation of profit”. This phrase, which forms part of the definition of personal or living expenses in section 248 of the Income Tax Act, has been the subject of much litigation. The recent decision of the Federal Court of Appeal in Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001 has, it is to be hoped, laid to rest some of the misunderstandings surrounding the ambit of the obiter dicta in Moldowan v. R. (sub nom. Moldowan v. Minister of National Revenue), (sub nom. Moldowan v. The Queen), [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213.

In this case the appellant seeks to deduct losses of $28,259.52, $11,711.51 and $17,820.00 sustained in respect of the house in Tucson.

The appellant is a lawyer practising as a sole practitioner in Aylmer, Ontario. He was called to the bar of Ontario in 1975.

Shortly after setting up practice he bought a triplex with another person and kept it for three or four years. Although the co-owner was supposed to deal with the tenants they frequently would see the appellant about problems. Later, he bought an office building in St. Thomas of which the upper floor was rented to a church group. He occupied the lower floor. Neither of these real estate investments worked out and both buildings were sold. Next he bought a building in Aylmer with an office in the back. Ultimately that building was lost under a power of sale in a mortgage.

In 1980, the appellant and his wife visited Tucson, Arizona, on holiday. It was at that time a city of about 500,000 persons. It is located ap- proximately 120 miles south east of Phoenix and about 100 miles north of the Mexican border. They found it an attractive city and since that time the appellant and his family have visited it a number of occasions on vacation. The appellant in 1981 bought a house in an older area of Tucson. He paid $60,000 US of which $49,000 was financed by a first and second mortgage. He rented it out on a yearly basis for about $400 per month, a rental which yielded an annual loss of about $3,000. He became dissatisfied with the investment and sold it in 1986 for $62,000 US.

The appellant and his family kept going to Tucson and he became aware of a new development in Tucson, “Fairfield in the Foothills”. It appears to have been a somewhat upscale development and he viewed Tucson as a place to which upper income retirees would come on a seasonal basis, as well as movie producers for periods of time when filming movies.

He found a house in the subdivision at 4500 N. Placita Del Tio. It was a one storey, single family structure. He bought it in January 1989 for $220,000 US. The purchase was financed by a first mortgage of $156,626.39 and a second mortgage of $42,759.00. The balance due on closing, after adjustments, was $22,875.46. This was financed, at least in part if not entirely, by a loan from a Canadian bank to the appellant’s practice followed by a payment to him of his capital in the practice. Although the Department of National Revenue originally disputed the deductibility of the interest on the loan to the practice, it was ultimately accepted that the interest on that loan was deductible, and the point is not in issue here.

The interest under the first mortgage was originally 8 per cent per annum, but it was adjusted to 10 per cent per annum in 1990. For 1993 the interest rate under this mortgage was adjusted to 8 per cent. The interest under the second mortgage was also adjusted and ranged from 10.75 per cent annually in 1989 to as low as 6.5 per cent in 1992.

In addition to the cost of the house the appellant spent about $30,000 US on furniture and fixtures and an additional $6,000 on capital improvements.

The appellant had some success in renting the property. The attached Schedule I, which was entered as Exhibit A-4, shows the actual rents received and the costs up until 1995. The property was sold in March 1996. Schedule II also Exhibit A-4 is a projection that was prepared and given to the Department of National Revenue at the time the assessment was being discussed, either at the objection or the assessment level. Evidently no such projection was made at the time the property was purchased. Schedule III is a comparison of the actual results from 1990 to 1992 with the projected results and was adduced as Exhibit A-14. The figures shown under “Budget” can not in every case be reconciled with the figures in Schedule

II. For example the projected rents for 1990 to 1992 inclusive totalled $90,700 US, not $81,730.

From the figures in these schedules, a number of observations might be made. The difference between the interest paid and projected over these three years was $6,389 — a relatively small amount in the overall picture. The largest difference between the projections and the amounts realized by the appellant is attributable to the failure to obtain rentals that were anywhere close to those that he expected. The appellant testified that he expected about $2,800 per month during the “high” season, and about $2,100 per month in the “low” season and a 10 per cent vacancy rate. Had these expectations been realized, he would have had gross rentals of about $26,500 US per year and he would have had a loss in 1990 and in 1991 and a profit in 1992, 1993 and 1995. In fact a small profit was realized in 1994.

In applying the Tonn decision, as well as the approach that I have taken in a number of other cases referred to in Tonn, I am aware that it is not the place of this court to second-guess the business acumen of a taxpayer who embarks bona fide on a commercial venture that turns out to be less profitable than he or she anticipated. I need not repeat what has been said on other occasions.

Moreover, the Tonn decision supports the allowance of a reasonable period for a business to get started. Nonetheless, there must be sufficient of the indicia of commerciality to justify the conclusion that a real commercial enterprise is being conducted. Where there is no personal element, and the enterprise has a sufficient degree of economic realism to warrant a finding that a business genuinely exists, the Tonn decision supports the deduction of losses. Do these elements exist here? I think not. If one steps back a few paces and looks at the matter with a purely commercial eye, what does one see? A lawyer from Aylmer, Ontario who finds an attractive city in the middle of the desert in southern Arizona about 2,000 miles from Aylmer. Over the years Tucson, Arizona becomes a place where he an his wife enjoy vacationing. He buys one house and, after a bad experience in renting it, sells it. Later, he buys for $220,000 US another house in an upscale area hoping to obtain high, short term rentals from movie producers and affluent snowbirds. He spends a further $30-40,000 US furnishing it. He and his family sometimes stay there when it is not occupied. The purchase is financed to the hilt, by a first and second mortgage and the balance is financed by a borrowing from a Canadian bank — admittedly by his law practice with the immediate purpose of paying out his capital in the proprietorship, but realistically the borrowed moneys went into the Tucson property.

There is certainly a personal element involved here and, given the financing arrangements and the unrealistic expectations for the incomeproducing potential of a single family dwelling located about 2,000 miles away it is impossible to see this as having the requisite degree of commerciality to justify the deduction of the losses sustained. The case falls far closer to my decisions in Cheesemond v. R. (sub nom. Cheesemond v. Canada), [1995] 2 C.T.C. 2567 (headnote only) (T.C.C.), and Fish v. R., (sub nom. Fish v. Canada) [1995] 2 C.T.C. 2755 (headnote only) (T.C.C.) than it does to such cases as Smith v. R., [1996] 1 C.T.C. 2022 (headnote only) (T.C.C.) and the other cases cited in Tonn.

The appeal is therefore dismissed with costs.

Appeal dismissed.