Prince v. R., [1997] 2 CTC 2286

Mogan T . C.J.:

These appeals are in connection with two taxation years, 1991 and 1992. The appeals turn mainly on their facts. In each of the years under appeal, the Appellant deducted in computing income rental losses. The total amounts of those losses were disallowed by the Minister of National Revenue. He issued reassessments in respect of the two taxation years. The only issue before the Court is whether the rental losses may be deducted by the Appellant in computing her income. The amounts are significant.

In 1991, the Appellant had employment income in excess of $60,000, and she deducted a rental loss of $41,931. In 1992, the Appellant had employment income in excess of $45,000, and she deducted a rental loss of $30,351. Those rental losses came about from the following transactions. In 1986, the Appellant purchased a property at 44 Roxaline Street in Etobicoke, paying $125,000. She moved into the “Etobicoke property,” or the “Roxaline property”, and it was her principal residence from 1986 to 1989. Of the purchase price of $125,000, she borrowed $115,000 by way of one or two mortgages, and so she invested only $10,000 of her own capital in the property.

In 1989, the Appellant purchased a second property in Scarborough at 5 Whistling Hills Drive. The purchase price of this property was $330,000. The Appellant financed the purchase price to the extent of $300,000 and put $30,000 of her own capital into the Whistling Hills property, which I will sometimes refer to as the “Scarborough property”. In 1989 she moved from the Etobicoke property to the Scarborough property and attempted to rent the Etobicoke property, asking a rent of approximately $1,200 per month. She was not able to obtain that high a rent, and within a year or two, had reduced the rent to approximately $800 or $900 per month. The tenants in the Etobicoke property, who occupied it for parts of 1989, 1990 and 1991, were not responsible tenants, according to the evidence of the Appellant. They did significant damage to the property and she was required to do significant repairs when the tenants vacated the property in 1991.

She then sold the Etobicoke property for approximately $200,000 in July 1991, and in order to finance the continued ownership of the Scarborough property, she moved out of it in the middle of October 1991 and rented it for the last two and one-half months of 1991 and for part of 1992. The evidence is that the first tenant moved out in July 1992 because of a failure to pay rent for a couple of months. Also, in 1989, in order to help finance the purchase of the Scarborough property, the Appellant increased the mortgage on the Etobicoke property from its original amount of $115,000 to some higher amount, probably in the range of at least $150,000, because Exhibit R-4 indicates that in 1992, the mortgage on the Roxaline property had gone up as high as $150,000.

Now, we come to the statement of real estate rentals, which was attached to the Appellant’s income tax returns for 1991 and 1992. The 1991 income tax return is Exhibit R-l. The Appellant’s statement of real estate rentals shows gross rent from 5 Whistling Hills Drive and from 44 Roxaline Street together. It should be remembered that the Roxaline property was rented until about the beginning of the summer of 1991 and the Whistling Hills property was rented in the last two and one-half months of 1991. The statement shows total rental of $8,950, total expenses of $50,881, and therefore a loss of $41,931, which is the amount claimed by the Appellant in her income tax return.

Some of the more significant expenses for 1991 are as follows: property taxes, $4,920, interest on the mortgages, $31,920 and light, heat and water, $2,600. The expenses claimed by the Appellant and deducted are so much in excess of the declared rent that I have no hesitation in concluding that there was no reasonable expectation of profit from renting these properties in the 1991 taxation year. I find that the Appellant has tilted the scales about as far as one could reasonably do in terms of maximizing the loss in order to have higher deductions from the computation of her income. I have to compute that in that way because of the manner in which she calculated her expenses.

Counsel for the Respondent brought forward three exhibits which show that in 1991 the municipal taxes on the Roxaline property in Etobicoke were $2,230 and the municipal taxes on the Whistling Hills property in Scarborough were $2,689, for a total of $4,919. The Appellant deducted that amount as municipal taxes in the computation of her rental loss when it should have been perfectly obvious to her she did not own the Roxaline property for the whole of the calendar year 1991. She only owned it until July, and would have received a tax credit from a purchaser on closing. Also, she used the Whistling Hills property in Scarborough as a personal residence for the first eight or nine months of the year, because she only moved out when she returned to the rental property in Etobicoke in the last half of 1991.

In those circumstances there is no justification in computing income to deduct in 1991 all of the municipal taxes attributable to either the Whistling Hills property in Scarborough or the Roxaline property in Etobicoke. Therefore, I have to conclude that she was tilting the balance of expenses in her favour to make the loss bigger in order to have a larger amount to deduct from her employment income in 1991. On the face of her return, she claimed a refund of $14,102, which would be the amount refundable to her from the source deductions that had been taken in respect of her employment income from two employers, when her aggregate employment income was in excess of $60,000.

I found the Appellant’s evidence evasive at times and I will cite two examples of that. She was asked in cross-examination what she sold the Roxaline property for in 1991, which is only five years ago. At first she said she could not remember, and when it was put to her in further cross-examination that she sold for a price of $200,000, she still indicated that she could not really confirm that amount. However, after a few more moments, she agreed that the sale price could have been in the range of $200,000. I regard those kind of answers as evasive, because most of us do not purchase that many significant parcels of real estate in our lifetime. Generally, with transactions of that magnitude, both the purchase price and the selling price are ordinarily fixed in the mind of a person for a significant number of years after the transaction. Perhaps with only a few transactions like that in a lifetime, purchase and selling prices are in our minds forever.

The other example of evasiveness was in the cross-examination of the Appellant’s failure to report the sale of the Roxaline property in her 1991 tax return. She maintained that, although there appeared to be a gain on the sale of the property because she paid $125,000 for it in 1986 and sold it for a price in the range of $200,000 in 1991, the repairs she was required to do to that property as a result of the irresponsible treatment by the tenants would have wiped out any gain. That may be true, but that would mean that the repairs would have had to be in the range of $75,000. She brought to Court no documents indicating that she had been obliged to spend $75,000 fixing up the property. She did not mention it was a principal residence for herself for three years. I would have thought that was a possible reason for saying that she did not think she had to report it because it was her principal residence. I would have questioned the reasonableness of her explanation that it was not her principal residence throughout the period of her ownership. She lived in the Roxaline Street property for only three years, from 1986 to 1989, and had converted it, though she thought it was a residential property in 1989. She ought to have reported the proceeds of sale and explained them, either by reducing the proceeds through necessary renovation costs or otherwise, because it was a disposition of a significant capital asset in 1991.

I have one further comment in connection with the 1991 return. I have shown that the Appellant deducted the full property taxes and mortgage interest on both houses in 1991. The mortgage interest deducted on the statement of real estate rental attached to her 1991 income tax return is $31,920, and Exhibit R-4 shows that the 1991 interest on the Scarborough property was $18,548 and on the Roxaline property was $13,372, for a total of $31,920. This is the full interest deducted, resulting in this loss of $41,931 for 1991. It seems that the Appellant has gone out of her way to inflate or build up the expenses to create a high rental loss. The result is that the expenses claimed are so unreasonable that there could not be a reasonable expectation of profit of any kind for 1991.

Counsel for the Respondent drew my attention to the recent decision of the Federal Court of Appeal in Tonn v. R., (sub nom. Tonn v. The Queen) [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.), and in particular, the following statement of Linden J. at page 225 (D.T.C. 6013):

... the Moldowan test should be applied sparingly where a taxpayer’s “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

There is a personal element involved in the Etobicoke property, because it was used as her personal residence from 1986 to 1989. Similarly, the Appellant turned the Whistling Hills property into a principal residence property because she moved in in 1989. She moved out in the fall of 1991, after selling the Etobicoke property and realizing she needed some kind of rental to help reduce the carrying costs of the Whistling Hills property.

Turning to the 1992 taxation year, much of what I said in connection with 1991 has similar application in 1992. In that year, the Appellant showed rental income from the Whistling Hills property of $12,000. She showed expenses of $42,351 and claimed a rental loss of $30,351. She acknowledged that the $12,000 rent was not really all received, for some reason, which puzzles me, and the same applies to 1991. She included rent in income, which she should have received if the tenant was not irresponsible and did pay the rent. I asked her at the end of her evidence why she would do that, because my experience is that no taxpayer ever shows, discloses or volunteers an amount of rental income or revenue that has not, in fact, been received. The Appellant did not really have a very satisfactory explanation for that. I would have thought that a person would not report rental revenue if it was not actually received in hand. This is not like a manufacturing business, where you have to show sales, whether they are paid for or not, and maybe at some later stage set up a reserve for doubtful debts. Calculation of what I would call casual rental income from a rental of one or two residences is usually reported on a cash basis.

In any event, for 1992, the rental revenue amount of $12,000, by the Appellant’s own admission, is a little too high. She did not really receive that much, but she claimed expenses of $42,351 and they are significant. For example, the interest on the Scarborough property alone was $19,477, the property taxes were $2,900, and she has included an amount for legal and administrative charges of $7,177. I have not itemized all of the expenses but the total $42,351 results in a loss of $30,352.

I come back to the words of Linden J. mentioned above: “where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was, in fact, a business”. In my view, the alleged expectation of profit was unreasonable, having regard to expenses of $42,000 against rental revenue of less than $12,000. The Appellant was called upon to justify objectively that the operation was a business and she has not done that.

She was questioned also on certain alleged losses in the adjoining years. I say alleged losses because in the Minister’s Reply to the Notice of Appeal, he says that he assumed that in the years 1989 and 1990, the Appellant had deducted losses with respect to the Etobicoke property of $16,000 and $22,000, respectively. The Minister also assumed in 1987 and 1988 that the Appellant had claimed losses in respect of the Etobicoke property of $14,000 and $26,000, respectively, when it was not even a rental property.

I informed counsel for the Respondent that I did not put much weight in those assumptions if she did not produce the tax returns upon which the assumptions were based. Also, the Appellant had the Reply to the Notice of Appeal and could have come to Court prepared to answer the assumptions, but basically was not in a position to provide her own documents in denial of those losses. I do not put much reliance on that, but it does colour my thinking in terms of what I have referred to as the evasiveness of the Appellant in explaining what she did. She is obviously an intelligent woman who prepares her own income tax returns, and if she had turned them over to a commercial income tax return office, I could find it a little easier to accept. Therefore, I think it is more difficult for her to say that I do not remember or, no, I categorically reject that suggestion and I never did deduct those losses.

The Appellant was unable to take that position. She did acknowledge that in the years 1993 and 1994, she claimed additional losses of $17,000 and $19,000, respectively, in connection with her attempt to rent the Scarborough property. I do not have to determine anything about those years, but it does contribute to the overall picture that there was no expectation of profit in renting the Scarborough property in the years under appeal. It was so heavily burdened with debt and the interest on the mortgage was so great that the possibility of getting rent equal to the mortgage interest was not a reasonable expectation.

For these reasons, I dismiss the appeals for the 1991 and 1992 taxation years.

Appeals dismissed.