Egger v. R., [1998] 2 C.T.C. 2106, 98 D.T.C. 3372

O'Connor T.C.J.:

1 These appeals were heard at Toronto, Ontario on November 19, 1997 pursuant to the Informal Procedure of this Court. Testimony was given by Mr. Egger and several exhibits were filed by both parties.

Issue

2 The only issue in these appeals is whether the Appellant is entitled to deduct certain rental losses claimed in the years 1992, 1993 and 1994 with respect to a residential property in Port Charlotte, Florida (“Property”).

Facts

• 1. In computing income the Appellant claimed rental losses from the Property in the following amounts, namely $9,455 in 1992, $7,745 in 1993 and $8,049 in 1994. In 1995 the loss was $7,000 and in 1996 the loss was $3,700.

• 2. The details of the rental losses are set forth in Schedules A1, A2 and A3 to the Minister's Reply as follows:

  Schedule “A1”

  1992
  Gross rental income	$16,750
  EXPENSES:
  Maintenance and Repairs	$ 669
  Interest	18,556
  Property Taxes	6,963
  Insurance	268
  Utilities	1,379
  Telephone	451
  Travel	310
  Less: Personal use	(2,391)
  26,205
  Net Income (Loss)	($9,455)

  Schedule “A2”

  1993
  Gross rental income	$8,160
  EXPENSES:
  Maintenance and Repairs	$1,648
  Interest	8,225
  Agency fees	1,705
  Professional fees	102
  Light, Heat water	2,016
  Insurance	316
  Property Taxes	1,893	15,905
  Net Income (Loss)	($7,745)

  Schedule “A3”

  1994
  Gross rental income	$6,362
  EXPENSES:
  Maintenance and Repairs	$2,378
  Interest	7,553
  Light, Heat water	2,017
  Insurance	414
  Property Taxes	2,049	14,411
  Net Income (Loss)	($8,049)

  It is to be noted that Schedule A1 actually reflects income and expenses related to the Property as well as to another property which the Appellant rented out in that year. Suffice it to say that the loss incurred in 1992 from the Property was at least $9,000.

• 3. In 1990, the Appellant was 54 years of age. In December of that year he purchased the Property for $135,677 Canadian funds. The Appellant at all material times was the owner and manager of Egger Excavating Ltd. and had employment income from that company. The vendor was Port Charlotte Florida Homebuilders RD Ltd. (“Homebuilders”). Homebuilders was a Canadian based corporation specializing in constructing, selling and managing properties in Florida. The Appellant, in purchasing the Property, relied on certain representations by Homebuilders and attempted to verify projected rentals from owners of similar properties in the area. In conjunction with purchasing the Property, the Appellant contracted with Homebuilders to act as property manager and rental agent.

• 4. The purchase was fully financed by a three year mortgage taken on the Appellant's Ontario residence at an interest rate of 141/4%.

• 5. The Appellant's evidence was that he only used the Property for approximately two weeks in each of the years in question. This is also reflected in paragraph 8(d) of the Minister's Reply. An attachment to the Appellant's Notice of Objection (Exhibit R-3) indicates slightly longer periods of occupation by the Appellant but the Appellant testified that two weeks was probably the correct figure. The Appellant further testified that the two weeks were spent mainly with landscaping and other work on the Property.

• 6. The Appellant expected losses in the early years of rental mainly because of the high interest expenses. The Appellant testified further that the acquisition of the Property was strictly for rental purposes and only approximately 15 years later was it to become the retirement home for the Appellant and his wife.

• 7. Efforts of the Appellant to make the Property more profitable included the following:

  • (a) the landscaping and other work done on the Property;

  • (b) the fact that the interest rate on the mortgage after the initial term of three years was replaced by another mortgage at 8% and the Appellant switched to a weekly payment schedule to reduce the mortgage more quickly;

  • (c) the Appellant did some marketing by means of a video and speaking to his friends in Ontario hoping that they would rent the Property; and

  • (d) in February, 1995 the Appellant, unsatisfied with Homebuilders, cancelled their agency and hired another agency that was able to market the Property throughout Europe and North America at a lower agency fee.

• 8. In 1997 the Appellant testified that he will show a profit from the Property of approximately $1,200.

• 9. The Appellant also testified that his rentals were lower than originally anticipated for various reasons, including fears in Canada concerning the crime rate in Florida, the exchange on the U.S. dollar and changes in the Ontario Health Insurance Plan limiting amounts that Canadians could recover in the event of illness or accidents occurring in the United States. These assertions were not corroborated by any independent evidence.

Submissions of the Appellant

4 The Appellant submits that he anticipated losses in the early years and he realized that those losses would be caused mainly by the high interest charges. He asserts, however, that it is clear from the limited use of the Property by himself and his wife in each year that the Property was intended as a rental unit. Further, the fact that they only intended to use the Property as a personal residence, i.e. a retirement home, approximately 15 years after the acquisition is a strong indication that the Property was acquired as a rental property. He further submits that when the interest rate was reduced from 14 1/4% to 8% and the new agency took over, matters improved considerably leading to his estimated profit for 1997 of approximately $1,200. He submits that all of the evidence must lead to the conclusion that he had a reasonable expectation of profit after the reasonable start-up period had expired.

Submissions of the Respondent

5 The Respondent submits that there was no reasonable expectation of profit. No adequate planning was done, no projections were made and the Property could not show a profit because of the 100% financing with the attendant high interest expense. Further, even after the interest rate dropped, losses still continued. Moreover, the Appellant should have switched agencies earlier.

Analysis and Decision

6 The most recent decisions of the Federal Court of Appeal on matters of this nature are Tonn v. R.[FN1: <p>(1995), [1996] 2 F.C. 73 (Fed. C.A.)</p>] , Mastri v. R.[FN2: <p>(27 June 1997), A-650-96, A-651-96 (Fed. C.A.), [Reported(1997), 97 D.T.C. 5420 (Fed. C.A.)]</p>] , Mohammad v. R.[FN3: <p>(28 July 1997), A-652-96 (Fed. C.A.), [Reported(1997), 97 D.T.C. 5503 (Fed. C.A.)]</p>] , and Watt v. R.[FN4: <p>(September 24, 1997), Doc. A-332-95 (Fed. C.A.)</p>] , the last a decision of the Federal Court of Appeal dated September 24, 1997. In Watt, the court concisely described the gist of the earlier decisions in Tonn and Mastri as follows:

...a fair reading of Tonn and Mastri allows us to posit: a) that a personal element may coexist with a profit motive; b) that where a personal element exists, it will prompt the Court to apply the reasonable expectation of profit test more assiduously; and c) that where the personal element is “the dominant, motivating force”, the taxpayer's burden may be considerably more onerous.

The above analysis is to the effect that there can be no reasonable expectation of profit so long as no significant payments are made against the principal amount of the indebtedness. This inevitably leads to the question of whether a rental loss can be claimed even though no such payment(s) were made in the taxation years under review. I say yes, but not without qualification. The taxpayer must establish to the satisfaction of the Tax Court that he or she had a realistic plan to reduce the principal amount of the borrowed monies. As every homeowner soon learns, virtually all of the monthly mortgage payment goes toward the payment of interest during the first five years of a twenty to twenty-five year amortized mortgage loan. It is simply unrealistic to expect the Canadian tax system to subsidize the acquisition of rental properties for indefinite periods. Taxpayers intent on financing the purchase of a rental property to the extent that there can be no profit, notwithstanding full realization of anticipated rental revenue, should not expect favourable tax treatment in the absence of convincing objective evidence of their intention and financial ability to pay down a meaningful portion of the purchase-money indebtedness within a few years of the property's acquisition. If because of the level of financing a property is unable to generate sufficient profits which can be applied against the outstanding indebtedness then the taxpayer must look to other sources of income in order to do so. If a taxpayer's other sources of income, e.g. employment income, are insufficient to permit him or her to pay down purchase-money obligations then the taxpayer may well have to bear the full cost of the rental loss. Certainly, vague expectations that an infusion of cash was expected from Aunt Beatrice or Uncle Bernie will not satisfy the taxpayer's burden of proof. In practice, the taxpayer will discharge that burden by showing that significant payments were in fact made against the principal indebtedness in the taxation years closely following the year of purchase.

7 Cases dealing with expectation of profit are many and varied and it is clear that each case must be judged on its own set of facts.

8 In a decision of the undersigned rendered November 23, 1995 in Pope v. R.[(1995), 97 D.T.C. 147 (T.C.C.)], I, in relatively comparable circumstances, decided that the appellant in that case did have a reasonable expectation of profit with respect to rentals from a Florida rental property. Several of the reasons for that decision apply in these appeals. The Appellant's use of the Property (personal element) was minimal. His intention to only occupy the Property 15 years later is consistent with an intention to rent in the interim. Interest on the mortgage was reduced. A profit was projected for 1997 and there is no evidence to contradict this.

9 In conclusion, I am satisfied that the Appellant, at the time of the purchase, expected that after a reasonable period of time he would realize rental profits. He was entitled to a reasonable start up period. In other words, I find the Appellant had a reasonable expectation of profit and consequently the appeals are allowed with costs.