Desgens v. R., [1998] 1 CTC 3259

Archambault T.C.J.:

Clifford Boussada, Jr., Fernand Desgens and Roger Lepitre are challenging notices of assessments made for the 1992 and 1993 taxation years by the Minister of National Revenue (“the Minister”) pursuant to the Income Tax Act (“the Act”). The Minister disallowed the deduction of rental losses made by each of the appellants on the ground that there was no reasonable expectation of making a profit from the rental of their condo unit in a complex known as “Place Chelsea” and located on Rue Principale in Cowansville, Quebec.

Facts

Mr. Boussada is a furniture dealer. His business is one of the most prestigious in the Cowansville area. In the early 1980s Mr. Boussada wanted to diversify his operations and decided to build and sell a condominium complex in the town of Cowansville. The Place Chelsea complex is located in a rural setting near the Cowansville hospital and the courthouse. At the time, it was a new concept for the area. It was a condo complex including both residential and commercial sections. At the back of the building were 18 luxury apartments spread over five floors and at the front the commercial section, leased to a pharmacy, a dental clinic and a medical clinic. Place Chelsea offered elevators, well soundproofed units, indoor parking and individual air conditioning.

In order to complete his project Mr. Boussada took in investors, who financed the project, in a limited company (“the company”). Mr. Boussada looked after all aspects of the project, including purchasing the land, hiring architects and a building contractor, and selling the units. Before construction began in 1986 the company had already sold half the condo units. When the building opened in 1987, 13 of the 18 units had been sold. Two- thirds of the units sold were occupied by their owners while one-third were rented.

Michael Murray, a real estate broker, testified as an expert witness and confirmed that the economic situation prevailing between 1983 and 1987 favoured the construction, sale and purchase of condo units in the Cowansville area. In view of the inflation which had existed up to then, there was every reason to think that such condo units could be resold at a profit without too much difficulty. Cowansville is a service location for the Knowlton and Bromont areas where large businesses such as Hyundai, IBM and Mitel are located. The Cowansville area is located in a resort district where there are ski slopes, including Bromont and Mount Sutton, many lakes and some 17 golf courses which are 30 minutes by car from Cowansville. Further, an expansion of the Cowansville hospital and courthouse had been announced.

Among the first condo unit purchasers were Messrs. Desgens and Lepi- tre, the shareholders in a building company which had obtained the contract to build Place Chelsea. They acquired co-ownership of a four-and-a-half room unit for $97,325, which they in fact borrowed. Although the purchase was made on September 2, 1987 the rental did not begin until November 1, 1989. The monthly rent was $800. The gross annual rental income for 1989 to 1993 inclusive was as follows:

The rental losses on this unit for the same period were as follows:

For the same period the interest expenses and real estate taxes for the unit were $12,437, $13,712, $15,316, $15,078 and $11,082.

In his testimony Mr. Desgens stated that he purchased this unit to rent it. However, he frankly admitted that if he had received a good offer he would have agreed to sell it. The condo was in fact for sale or rent in 1988. Mr. Boussada made efforts to rent it or sell it. In 1989, according to the testimony of Mr. Desgens, Mr. Leduc, a Royal Lepage broker, tried to sell it or rent it. A contract of mandate with Royal Lepage, dated September 7, 1990, was entered in evidence. It was a power of attorney to sell for $135,000 or to rent at $800 a month. A similar mandate was given to Remax in February 1993, to Trans-Action Mississiquoi in February 1994 and to Royal Action, a real estate broker, in January 1996. The selling price asked in the last contract of mandate was reduced to $109,900.

Early in 1991 only two units remained unsold. Mr. Boussada purchased them on January 31, 1991 for a total of $141,560. These units had five and a half rooms each. The price reflected essentially the building cost of the units to the company. When Mr. Boussada purchased them he did not check whether Messrs. Desgens and Lepitre’s unit had been rented or what rent they were charging. However, he knew that another owner was renting his unit, a penthouse, some $1,100 a month.

Mr. Boussada claimed no rental losses for 1991. However, in 1992 and 1993 the deductions claimed totalled $11,799 and $10,835 respectively. There was no gross income in those two taxation years. Mr. Boussada stated that he purchased the two units in question to rent them and to make a long-term capital gain. However, at the time of the audit, Mr. Boussada indicated in a questionnaire that was given to him by the Minister’s auditor that he had bought them “‘to resell and turn a profit”.

In January 1992, less than a year after buying them, Mr. Boussada gave a real estate broker a power of attorney to sell his two units. The asking price was $153,000 for one and $165,000 for the other. No mention was made in these powers of attorney of the units being available for rental. Mr. Boussada maintained that his broker told him it was not necessary to mention it. On the other hand, in the brokerage contracts of Messrs. Desgens and Lepitre this point was mentioned. In June 1993, Mr. Boussada renewed his power of attorney and reduced the asking price for each unit to $99,000. He also took steps to sell or rent his units in June and July 1991, but without too much success.

According to Mr. Boussada, the rental asked for these units amounted to between $800 and $1,000. The average rental in the Cowansville area at that time was between $325 and $425 a month. In 1994 Mr. Boussada managed to rent one of the two units to a Mr. Bourassa for a few months. The latter subsequently purchased it.

At the time of the design and construction of Place Chelsea there was no other condominium complex in the Cowansville area. However, in 1987 a physician from the area, Mr. Breton, a pillar of his community, announced the construction of 64 condo units located not far from Place Chelsea, quite near the lake, in Cowansville. This building was of lesser quality than Place Chelsea: there was no elevator or indoor parking. Mr. Murray confirmed that the construction of Dr. Breton’s complex had the effect of creating a surplus of condo units for sale in the area, and in view of the downturn in the economic situation in the early 1990s Cowansville found itself with a large supply of rental apartments. Moreover, the Breton family, which was under financial stress, was forced to sell or rent its condo units at a reduced rate. Additionally, the expansion projects for the hospital and the courthouse were postponed and this did not encourage new professionals to settle in the area during the relevant period. It should be added that around 1992 Hyundai decided to shut down its factory.

All the appellants confirmed that they never used their condo units for personal reasons and each appellant had his own home in the area during the relevant years.

Analysis

The Minister assumed that the appellants had no reasonable expectation of profit in the relevant years. The appellants had the burden of showing that they held their condo units in the 1992 and 1993 taxation years in order to obtain rental income. On the basis of evidence heard, I am persuaded that was not the case. I think the appellants bought their condo units more in order to resell them at a profit than to rent them. It was for each of them an adventure or concern in the nature of trade. The facts supporting this conclusion are the following.

In Mr. Boussada’s case, he was one of the shareholders in the company, the real estate promoter who designed, built and sold Place Chelsea. Mr. Boussada played a significant part in promoting and selling this real estate complex. The purchase of his two condo units may be regarded as related to his occupation as a real estate promoter. The fact that Mr. Boussada could purchase his two units at promoter’s cost indeed encouraged him to speculate on the resale of these units at a profit.

It is true that in his testimony he stated that his primary intention was to rent and that the low price he paid enabled him to make a profit on rental more readily. However, his actions were not consistent with this statement since Mr. Boussada did not agree to reduce his rent in order to attract potential tenants. He did not want a low rent to reduce the resale value of his units. The legislation protecting tenants would have made it difficult for a new purchaser to increase the rent.

Mr. Boussada did not rent his two units from January 1991 to December 1993, a period of about three years. There was no evidence of any serious and sustained effort to rent his two condo units. Further, Mr. Boussada deducted no rental loss for 1991. It is true that his economic situation was not good in 1992 and 1993 and there was a surplus of condo units for sale or rental on the market. However, if he had really wanted a tenant I think he could have found one.

In his questionnaire Mr. Boussada indicated that his intention was to resell the units in question at a profit. I was not persuaded by his explanation that he was under stress when he completed it. I think his answer in the questionnaire was entirely consistent with the actions taken by him. It is also closer in time to the relevant events and more credible. The fact that Mr. Boussada put up his condo units for sale quickly after purchasing them indicates his intention was not to hold them for the long term. It is true he was unable to sell them quickly. However, it was the economic conditions prevailing at the time which prevented him from attaining this objective.

In conclusion, his actions were more like those of a speculator than an investor wishing to rent buildings for the long term. Accordingly, I conclude that Mr. Boussada had a reasonable expectation of profit from the resale of his two condo units but not of obtaining rental income. As I held in Stein v. R. (1996), 96 D.T.C. 1526 (T.C.C.), when a taxpayer purchases real property for a speculative purpose, the carrying costs, such as real estate taxes, condo fees and maintenance costs, must be capitalized and included in the inventory cost of his property. At 1532, I said the following:

In conclusion, carrying costs of real property held as inventory must be capitalized and cannot, for tax purposes, be deducted as running expenses in the year they are incurred.

The following conclusion, which I adopted at the same page in that case, also largely applies here:

In my view, the Minister acted properly in disallowing the rental losses. The evidence has established clearly that Mr, Stein did not acquire the condo for the purpose of earning rental income. At the time of acquisition of the condo, Mr. Stein never intended to rent it and to make a profit from such activity.

Instead, he acquired the property for the speculative purpose of reselling it quickly at a profit. At first, that is what he attempted to do. When this failed, he tried to either sell or rent the property. Clearly the intention to rent was only ancillary to the overall business objective pursued by Mr. Stein of selling the condo at a profit. The rental income would only mitigate his carrying charges while he held on to the property until its disposition.

An amount for selling cost could have been deducted pursuant to ss. 9 and 10 of the Act in the relevant years: see the Supreme Court of Canada judgement in Friesen v. R.! [1] Under s. 10, it is possible to value property in inventory at the lesser of the cost to the taxpayer or its fair market value. However, there is no evidence here of the fair market value of the condo units and so no amount can be fixed under ss. 9 and 10 of the Act.

I make exactly the same findings with respect to Messrs. Desgens and Lepitre. The reasons are as follows: Messrs. Desgens and Lepitre were shareholders in a building company which was engaged in a commercial activity connected with real property. Moreover, their company’s services were retained for the building of Place Chelsea.

In his testimony, Mr. Desgens indicated that their condo unit had not been rented for the first two years in which they held it. The level of rental income reported does not indicate significant rental activity between 1989 and 1993 inclusive. However, Mr. Desgens frankly admitted that his unit would have been sold if he had been offered a good price. The evidence further disclosed that from 1988 onwards, only a few months after the condo unit was bought, steps were taken informally to sell it. Written powers of attorney were later signed and renewed several times between 1990 and 1996.

Messrs. Desgens and Lepitre borrowed the entire purchase price of their unit. The amount of the interest payable and real estate taxes exceeded the amount of rental which they could expect to receive in the relevant years in which they held on to the unit. When we add the other expenses inherent in holding rental property, it is clear that Messrs. Desgens and Lepitre could not expect a profit from their rental activity in the short term. I am persuaded that the rental income served only to reduce the cost of holding the property until they found a buyer prepared to pay a good price, so that they could make a profit on the resale of their unit.

In conclusion, the unit of Messrs. Desgens and Lepitre represented inventory and their cost of holding it must be capitalized and included in the cost of the property.

For these reasons, the appeals of Messrs. Boussada, Desgens and Lepitre are dismissed.

Appeal dismissed.