Date: 20020131
Docket: 2000-2433-IT-I
BETWEEN:
DOUGLAS L. TITUS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Catherine Letellier De St-Just
Reasons for Judgment
(delivered orally from the Bench on
November 23, 2001 at Toronto, Ontario)
GARON, C.J.T.C.C.
[1] These are appeals from the reassessments of income tax for the 1994, 1995 and 1996 taxation years.
[2] By these reassessments the Minister of National Revenue disallowed rental losses in the amounts of $9,867.00, $10,367.00 and $7,984.00 for the 1994, 1995 and 1996 taxation years respectively in respect of a property located at Kirkfield, Ontario.
[3] The Appellant and a chartered accountant by the name of Mr. Philip Graham Dunn testified at the hearing of these appeals. The Respondent did not call any witness.
[4] The assumptions of fact in support of these reassessments are found in paragraph 5 of the Reply to the Notice of Appeal, which reads as follows:
(a) the Appellant purchased a seasonal recreation property: a cabin plus guest house (bunkie) located at R.R.#3, Kirkfield, Ontario (the "purported rental property") in August 1991 for $87,500;
(b) the Appellant financed the purchase with a $65,500 mortgage, which was renegotiated in October 1992 for a new amount of $85,500 with terms of interest only payments. Additional financing through a line of credit was arranged in August 1994 and December 1995 and the Appellant claimed 50% of the interest payments on the line of credit as rental expenses in 1995 and 1996 and 100% in 1994;
(c) in computing income for the 1994, 1995 and 1996 taxation years, the Appellant deducted rental losses with respect to the purported rental property;
(d) the rental income, expenses and losses, as reported by the Appellant in the respective taxation years are as follows:
1994 1995 1996
Gross Rent $1,100 $1,500 $1,500
Expenses (rounded)
Property Tax 896 841 833
Mortgage Interest 8,537 8,274 8,277
Insurance 528 528 504
Utilities 273 279 415
Maintenance & Repair 390 471 367
Motor Vehicle Expenses 770 690
Office Expenses 24 16
Other 234 1,085 142
Legal, Accounting 534 1,002
______________________________
Total Expenses $12,186 $13,186 $10,538
Less: Personal, 10% (1,219) (1,319) (1,054)
Rental Loss Claimed $9,867 $10,367 $7,984
(e) the Appellant also reported rental losses from the property in prior years as follows:
1991 1992 1993
Gross Rent Nil Nil $1,000
Rental Loss Claimed $3,213 $9,391 $8,347
(f) the appellant never made a reasonable effort to advertise or market the property to produce rental income;
(g) in the 1994, 1995 and 1996 taxation years, the rent charged was insufficient to cover the mortgage interest expense incurred;
(h) the Appellant had no reasonable expectation of profit from the alleged rental activity during 1994, 1995 and 1996;
(i) the rental expenses claimed were not made or incurred for the purpose of gaining or producing income from a business or property;
(j) the disallowed expenses were personal or living expenses of the Appellant.
[5] On behalf of the Appellant, subparagraphs (a), (b), (c), (d) and (g) of paragraph 5 of the Reply to the Notice of Appeal were admitted. Subparagraph (e) was admitted by the Appellant after the Respondent recognized that the Appellant had received rent in the amounts of $400.00 and $1,200.00 for the 1991 and 1992 taxation years respectively. The other subparagraphs of paragraph 5 of the said reply were denied by the Appellant.
[6] In his testimony, the Appellant, who was called to the Bar in 1977, mentioned that the recreational property was situated right on the lake, called Canal Lake, and is approximately sixty or seventy miles from downtown Toronto; it is not much more than one-hour drive from Toronto.
[7] The total area of the cabin is not more than 900 square feet. The building or cabin on the property was old. In the rental questionnaire dated June 4, 1999, the Appellant stated that the age of the property was approximately 45 years old. The cottage was winterized. There was also a guesthouse on the lot. According to the Appellant, there were nice trees on the lot, which had an area of between half an acre to three-quarters of an acre. The attractiveness of this lot is that it has 120 feet of shoreline. The lake fronting the property was part of the Trent Canal waterway system. It is not far from Lake Simcoe.
[8] The immediate portion of the lake bordering on the property has a sandy bottom and is shallow over a significant area. This environment was "great for the kids", to adopt the Appellant's phrase.
[9] The Appellant mentioned that he was familiar with the area since he frequented it from the time he was very young, his parents having had a cottage on this lake for a number of years. The proximity of his parents' cottage was a factor, according to his deposition, when he decided to purchase the subject property situated on the same lake.
[10] The Appellant testified that he thought at the time of the purchase of the property that he could rent out this property and earn income from it. He believed that he could get from $800.00 to $1,500.00 of rent "every one to two weeks". He also believed that the property could even be rented during the winter because access by car was possible during that season.
[11] The Appellant determined the rental value of the property by relying on advertisements in newspapers where rentals for cottages were listed. He did not however visit the properties referred to in the newspapers. The Appellant decided not to advertise in the newspapers on account, at least in part, of his financial situation. The Appellant was of the view that advertising by word of mouth through friends would be sufficient in the circumstances. However, his efforts at renting this property were not successful.
[12] His gross revenue from rentals amounted to only $400.00 in 1991 for a four-month period, $1,200.00 in 1992, $1,000.00 in 1993, $1,100.00 in 1994 and $1,500.00 in 1995 and 1996. He attributed this low gross revenue from rentals to the fact that the cabin lacked many amenities. Reference was also made to the economic situation prevailing at the time.
[13] The Appellant has also testified that substantial improvements and repairs were carried out on this property. According to paragraph numbered 8 of the rental questionnaire dated June 4, 1999, some of the work was done in 1994, 1995 and 1996. The work related to the outhouse, the well, the septic system, the roof and the TV antenna.
[14] At the time of the hearing of these appeals, the Appellant still owned the subject property. He indicated that at one point, he thought about selling this property but decided against this course of action.
[15] I turn now to the evidence relative to the financial aspects of this case, with respect more particularly the purchase of this property, its financing and improvements relating thereto, as well as the Appellant's financial circumstances.
[16] As appears from subparagraph 5(a) of the Reply to the Notice of Appeal, the subject property was purchased for $87,500.00, which the Appellant considered at the time to be an attractive price. The acquisition of the property was financed by a mortgage loan of $65,500.00 obtained through a mortgage broker with terms of interest-only payments. According to the rental questionnaire referred to earlier, the rate of interest was 12.5%. It was an open mortgage initially for a one-year term. The Appellant stated that he could not get financing from a bank. The mortgage loan was renegotiated in October of 1992 and the loan was increased to $85,500.00, as mentioned in subparagraph 5(b) of the Reply to the Notice of Appeal.
[17] At the time of the purchase of the property in issue the Appellant had just been employed as a lawyer at a salary of $65,000.00 per year. Immediately prior to August 1991, the Appellant had been unemployed for some time. In his new position he obtained no increase in salary until he was laid off in July 1994.
[18] The Appellant's income tax returns for 1994, 1995 and 1996 were filed with the Court. The tax return for 1994 shows that a) the Appellant had employment income in the amount of $49,769.59, b) he received unemployment insurance benefits in that year totalling $3,861.00 and c) net professional income in the amount of $1,870.00. For the year 1995 the tax return indicates that the Appellant had employment income of $37,804.00, received unemployment insurance benefits totalling $9,886.00 and net professional income of $1,648.00. For the 1996 taxation year, according to the tax return for that year, the Appellant had no employment income and received unemployment benefits of $6,720.00 and net professional income of $7,641.66.
[19] The document entitled "Projected Income & Expenses - Rental Property - June/July 1991" was filed with the Court. The Appellant testified that the foregoing financial statement had been prepared in 1999 at the request of the Canada Customs and Revenue Agency. The information contained in this document was based on his notes made a month or two prior to the purchase of the property and his recollection of his estimate of the projected income and expenses that he had in mind at the time. The relevant portion of the "Projected Income & Expenses - Rental Property - June/July 1991" is reproduced below:
INCOME
Rental Income
52 weeks @ $400/week $20,800
EXPENSES
Advertising 500
Property Taxes 750
Maintenance & Repairs 600
Insurance 250
Utilities 800
Beach Fees 75
Mortgage Interest 5,200
8,175
Less: Personal Use - 10% 818 7,358
_________
$ 13,443
_________
(Footnote omitted).
[20] In his evidence concerning the projected income and expenses referred to earlier, the Appellant stated that he planned to utilize the subject property for himself for about five weeks per year. This explains the notation towards the bottom of the statement where it is written "Less: Personal Use - 10%".
[21] The evidence of Mr. Dunn covers a few specific areas and does not add anything of significance to the Appellant's version of the facts.
Analysis
[22] The question in issue is whether the Appellant had a reasonable expectation of profit from the rental activity involving the subject property in the 1994, 1995 and 1996 taxation years.
[23] In considering this question the first matter that should be looked at is the financing of the acquisition of the property. Right from the beginning, almost 75% of the purchase price of this property was financed at a high rate of interest of 12.5%. Fourteen months later, that is in October 1992, refinancing occurred (probably by reason of the fact that substantial work and improvements had to be carried out on this property) and the amount of the loan was increased to $85,500.00, an amount almost equal to the purchase price of the property, which was $87,500.00 as noted earlier. There were other financing arrangements made in August 1994 and December 1995, the details of which were not provided at the hearing of these appeals.
[24] The mortgage interest expense in all the three years in issue was slightly in excess of $8,000.00 per year. This heavy financing burden must be viewed in relation to the amount of gross rentals generated by this property. For 1994 the amount of rental was $1,100.00, and $1,500.00 for each of the years 1995 and 1996. The interest payments on the mortgage alone exceeded in each of the years in issue the gross rental revenue by about five times after taking into account the 10% reduction of the expenses relating to the personal use of the property. If the other expenses are taken into account in each of these years, the expenses exceeded the gross revenue by a much greater margin.
[25] There is a further fact that in evaluating the totality of the evidence I find that the personal factors played a role in the Appellant's acquisition of this property. The Appellant admitted candidly that the fact that his parents owned a cottage on the same lake enticed him to purchase the subject property. He was also familiar with the area as he had been going to his parents' cottage for a great number of years. In addition, he himself was interested in spending his holidays at this cottage. The property was a vacation site.
[26] In considering the overall evidence in this case, I am also influenced by the fact that the Appellant did not appear to have made serious efforts with a view to renting this property. He did not advertise the property in the newspapers, which is a well-recognized method to attract potential customers. He gave certain explanations in this regard but I have not been persuaded by them. In any event, the Appellant has not disproved the assumption in subparagraph 5(f) of the Reply to the Notice of Appeal respecting the advertisement of the rental property.
[27] Among other considerations, the Appellant referred to external circumstances over which he had no control. The substance of this statement must be put into perspective. For instance, the loss of his employment in 1994 does not explain the lack of advertising in prior years. Also, at the time of the purchase of this property the Appellant was aware of his own financial situation and the constraints within which he had to operate.
[28] Regarding the chart showing the projected income and expenses, I have no difficulty in concluding that the projection of gross revenue and the interest expense relating to the mortgage were totally unrealistic. These projections are totally at variance with the economic financial reality prevailing at the time. Also, in establishing the projected total rental income, the Appellant stated that he relied on information provided by the newspapers, as mentioned earlier. However, he did not visit comparable properties, which were advertised for renting. I have difficulty understanding that it would have been costly for him to visit a few similar properties in the adjoining area with a view to having a general idea of the rental market for cottages.
[29] In view of the above, I have come to the conclusion that the Appellant did not have a reasonable expectation of profit from the rental operation involving the subject property in the years 1994, 1995 and 1996. Therefore, the Appellant is not entitled to deduction of the rental losses in each of the three years in issue.
[30] For these reasons, the appeals from the reassessments for the taxation years 1994, 1995 and 1996 are dismissed.
Signed at Ottawa, Canada, this 31st day of January 2002.
|
"Alban Garon" |
C.J.T.C.C.
COURT FILE NO.: 2000-2433(IT)I
STYLE OF CAUSE: Douglas L. Titus and
Her Majesty The Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: November 21, 2001
REASONS FOR JUDGMENT BY: The Hon. Alban Garon
Chief Judge
DATE OF JUDGMENT: November 30, 2001
APPEARANCES:
Counsel for the Appellant: The Appellant himself
Counsel for the Respondent: Catherine Letellier De St-Just
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada