Carrière v. R., [1998] 1 CTC 2152

Sobier T.C.J.:

The Appellant appeals from the assessments by the Minister of National Revenue (the “Minister”) for its 1991, 1992 and 1993 taxation years, whereby the Minister denied rental losses claimed by the Appellant for those years.

In January of 1989, the Appellant purchased a condominium known as Suite 1110, 3380 Eglinton Avenue East, Scarborough, Ontario (the “Property”). Prior to the purchase, the Appellant was not permitted by the tenants occupying the Property to examine it. However, he closed the purchase notwithstanding. After closing, he again experienced difficulty in gaining entry to the Property in order to effect repairs which he claims were necessary.

Based upon existing rent from tenants occupying the Property and subsequent increases in rent, the Appellant claims to have made projections until the year 2004, which indicated profitability by 1994. The profit was on what the Appellant claims to be a “cash flow basis”, but importantly, after $5,000 per year maintenance cost for the years 1989, 1990, 1991 and 1992 years.

The evidence as to the repairs required after the tenants vacated the Property fell short of the projected $5,000 per year, even in the first year. In fact, the amount claimed as current expenses for repair and maintenance were to the large extent of a capital nature, which of course increased the losses. The expenditures made for the first years and claimed as maintenance and repairs or replacement of damaged items were more in keeping with putting the Property into a condition satisfactory to the Appellant for his personal use as his principal residence rather than for rental purposes.

While the Appellant claimed that the Property was purchased to rent as a whole, he quickly changed this plan in about May 1989. Soon after the tenants moved out, he moved into the Property and decided to rent two of the bedrooms at $400 per month for each bedroom. He, of course, would occupy the third bedroom and share the other areas with the two tenants.

In May 1989, he claims to have reviewed his projections for the years 1989 to 2004 on the basis of shared accommodations and gross rent of $800 per month or $9,600 per year. Repair and maintenance of $5,000 per year were again budgeted for the first four years. These projections showed profitability again in 1994, after the deductions of two-third of the expenses from receipts.

The purchase price for the Property was $142,900 and was initially financed by a first mortgage by the Toronto-Dominion Bank of $107,000 for a term of five years, bearing interest at 12'/4 percent per annum and a second mortgage of $14,300. The second mortgage was paid within one year.

Prior to purchasing the Property, the Appellant claims to have studied mortgage rates and trends, determined the type of rental unit he would acquire (three bedrooms), its location and other factors. After closing, he also decided to lower costs by not keeping the property manager, thus saving property management fee. However, he was aware of the mortgage interest, condominium fees, property taxes and insurance. These fixed expenses greatly exceeded the gross rental which he could earn by renting as a whole or just two bedrooms. Neither projection took into account capital cost allowance. Accordingly, for the first five years, even without capital cost allowance, the Property would not show a rental profit.

The Appellant claims to have shown a profit in the 1994, 1995 and 1996 taxation years. However, for the most part, this was achieved by a reduction in expenses, especially mortgage interest, rather than raising rent.

Expenses other than the fixed expenses including interest, taxes, condominium fees, insurance, cable T.V. and telephone, dropped to $368 in 1994, $350 in 1995 and $248 in 1996. In 1991 and 1992, these were approximately $8,000 in each year and $1,000 in 1993, and to some extent on account of capital or for personal items.

It can be seen that after his problems began with Revenue Canada in late 1994 and early 1995, the Appellant reduced his costs for the 1993, 1994 and 1995 taxation years and thus showed a profit of $673.90 in 1994, $1,369 in 1995 and $1,755.06 in 1996, all before capital cost allowance.

Had the Appellant claimed only the fixed costs and supportable current expenses in the 1991, 1992 and 1993 taxation years, his gross income would still have been by far exceeded by those costs. This he knew before embarking in the venture. But by only claiming minimum operating expenses later and not attempting to include capital expenditures as current expenses, he was on the way to profitability.

By 1993, the mortgage was renewed at a lower rate of interest, bringing gross interest expenses in 1994 to $6,819, in 1995 to $5,796 and in 1996 to $5,177, thus allowing a small profit before capital cost allowance in those years. His projections were purportedly made in 1988 and 1989, when he predicted interest rates in 1994. He predicted that they would be about one- half of the rates in 1989 which appeared to be the case. Therefore interest expenses were reflected by a drastic fall in the interest rate and not by paying down the principal on the first mortgage as his projections for 1989, 1990, 1991 and 1992 set out.

In addition to projecting that interest costs would be reduced exactly as predicted in 1989, he also projected in 1989 that repair and maintenance would be reduced to about $200 per year, no doubt because he projected expending $5,000 per year on repair and maintenance between 1989 and 1993. However, these expenses were not incurred in those years.

The significant reduction of these two costs showed profitability on a cash flow basis in the projections commencing in 1993. However, the actual current expenses claimed in the years in question were greatly in excess of projections due mainly to expensing items which were capital and not income-producing in nature. In 1991, this included items such as $2,600 for a hot tub, $633.44 for an air conditioner. In 1992, he claimed $1,344 for a stove, ventilation and fans $970, oriental rugs $870, stereo speakers $63.25, kitchen doors $390.98 plus kitchen door jams and mouldings of $370.64 as well as shelving of $141.31 and a Viva telephone for $148.35. In 1993, he expended $624.32 for a comforter and bed linen.

By reducing his claims for expenses to a more realistic level and by not attempting to claim capital items which he began to do in 1994, coupled with reduced interest expense resulting not from the payment down of the principal on the first mortgage but by paying interest at a rate considerably less than at the outset, profitability was in sight.

I was not totally impressed by the Appellant’s evidence including his projections as to the reduction of interest costs, however such evidence was not seriously damaged under cross-examination and therefore should be accepted on the balance of probabilities.

The high interest payments in the beginning cannot be used as a reason for saying that there was no reasonable expectation of profit if circumstances changed as predicted. The Appellant was on the receiving end of the benefit of lower interest rates commencing in 1994. This should not prevent him from claiming losses resulting from legitimate operating expenses in prior years.

On balance, I am satisfied that the Appellant had a reasonable expectation of profit when he embarked on this venture. While there is a personal element present by reason of his living in the condominium, I do not believe it sufficient to overshadow the business aspects. The Appellant developed evidence as to the costs he would be expected to face, including evidence of the drop in interest rates after several years of operation. Although the expenses enumerated above, including the hot tub and air conditioner, should not be allowed and are not allowed, the appeal is allowed without costs and the matter referred back to the Minister for reconsideration and reassessment on the basis that after removing the above expenses claimed in the 1991, 1992 and 1993 taxation years, the Appellant be allowed his rental losses.

Appeal allowed.