Date: 19991209
Docket: 98-2181-IT-I
BETWEEN:
MAUREEN CRILLY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
_______________________________________________________________
For the Appellant: The Appellant herself
Counsel for the Respondent: Christine Mohr
_______________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench atToronto, Ontario, on November 23, 1999)
Bowie, J.T.C.C.
[1] In filing her income tax returns for 1993, 1994, and 1995, the Appellant claimed to be entitled to deduct from her other income certain losses she had suffered in connection with a condominium townhouse in Collingwood, Ontario. The amounts claimed are, for 1993, $9,433; for 1994, $9,959; and for 1995, $6,283.
[2] In March, 1997, the Minister reassessed the Appellant to disallow these losses, taking the position that the Appellant had no reasonable expectation of making a profit by renting the townhouse unit. The Appellant's accountant appears to have prepared the returns wherein her claims to deduct the losses were advanced and to have prepared or at least assisted in preparing her notice of appeal. She appeared before me in person to present her own appeal.
[3] The Appellant, along with her husband, his sister, and his sister's husband, purchased the townhouse unit. They each took a 25 percent interest. The offer to purchase was signed in 1988 or 1989, before construction had begun, and they took possession in December, 1990.
[4] It is common knowledge that the residential real estate market in Southern Ontario went through a period of very rapidly rising prices in the late 1980s culminating in a very sharp and rapid collapse of prices about the end of 1989 and 1990.
[5] The Appellant stated quite candidly in her evidence that it was her intention -- and I take it it was the intention of her co-owners as well -- to purchase this property, hold it for a short period of time, and then re-sell it at a profit. This is borne out by the fact that the entire purchase price of $212,000 was comprised of borrowed money. The first mortgage was for $159,000; the second for $13,000; and a down payment of $39,000 was acquired through a loan.
[6] There is no question in my mind that if the Appellant had, along with her co-owners, carried out the original plan they would have been liable for tax on the profit on the basis that it was an adventure in the nature of trade. Unfortunately for them, the real estate market collapsed in late 1989 or 1990, and the condominium unit could not be sold for anything approaching its purchase price by the time they took possession. The Appellant's evidence was that the value fell as low as $179,000 by early 1991. It was impossible to sell the property at such a loss, as the owners would have had to raise more than $30,000, over and above the sale price, in order to discharge the outstanding mortgages and the loan taken out for the down payment. They therefore had no alternative but to rent the property and try to make the best of a bad situation. With interest payments in excess of $7,000 per year and gross income of $4,000 per year, there was no possibility of making a profit from the unit as a rental property, as it was originally financed.
[7] Counsel for the Respondent took the position that the Appellant might have been able to derive more than the $4,000 per year in revenues which was actually received if she had been willing to rent the unit for short periods of time, rather than to restrict the rentals to established families for longer periods of time. This may be so, but it would have entailed both additional expense and significant risk of damage by short-term tenants. The decision to rent the property only for four-month periods was a rational business decision.
[8] Unfortunately, there proved to be no summer rental market for this property and, as a result, it could only be rented during the ski season, and the $4,000 which the owners were able to obtain for a four-month rental from the beginning of December to the end of March turned out to be all the gross income that they could achieve.
[9] In the result, the four owners received gross revenue of $3,750 in 1991 and $4,000 in each of 1992 to 1995, inclusive. Their expenses during these years were, so far as I can glean from the rather unsatisfactory evidence, in 1991, $21,682; in 1992, $23,376; in 1993, $22,866; in 1994, $23,908; and in 1995, $16,566.
[10] The Appellant said in her evidence that the second mortgage was paid off "prior to 1995", this explains the significant decrease in the expenses between 1994 and 1995. In addition, the owners were required to, and did, make two large lump-sum payments on the first mortgage, one in the amount of $10,000 in mid-1995 and the other in the amount of $40,000 in mid-1996. These payments were made a condition of extending the mortgages by the mortgagee. The second of these payments brought the outstanding principal balance on the first mortgage down to approximately $88,000.
[11] By 1977 the interest expense for the year had been reduced to about $3,000 and the total expenses to about $9,400 for the year. Revenue was about $9,600 and the Appellant declared a profit that year of $93.55. I digress here to point out that the Appellant, although she was only a 25 percent owner of the property, consistently claimed losses on the basis of 50 percent of the excess of expenses over revenue. In 1997 she declared 50 percent of the excess of revenue over expenses. In her evidence she said that she did so because her husband during those years had no income against which he might apply his 25 percent share of the losses. Quite clearly, if she is able to offset any of the losses at all, it is only to the extent of her 25 percent ownership interest.
[12] As I have said, the Appellant's returns, prepared by her accountant, claim rental losses as though this condominium was a rental property, and her notice of appeal, which no doubt also reflects her accountant's work, asserts "a reasonable expectation of profit" from "either rental or capital gain". However, there is no question about the Appellant's evidence that the property was purchased for quick resale at a profit, and, in my view, it is beyond question that it was bought as a trading asset, and not as a capital asset. Only the sudden decrease in value prevented resale at a profit.
[13] I did not understand the Appellant in her evidence to say that she and her co-owners had at any time abandoned the intention to sell this unit or to treat it as anything other than inventory. They did rent it, but I think only to try to salvage something from the wreckage of their original plan. I find from her evidence that there was no change in use of this property.
[14] The assumptions pleaded by the Respondent in the reply to notice of appeal include the following subparagraphs at paragraph 7:
(e) the disallowed rental expenses were not incurred for the purpose of gaining or producing income from a business or property;
(f) the disallowed rental expenses were personal or living expenses of the Appellant;
(g) the Appellant had no reasonable expectation of profit from renting the Property during the 1993, 1994 and 1995 taxation years.
The third of these is simply a plea as to the question of mixed law and fact before the Court. The second of them was thoroughly refuted by the Appellant's emphatic evidence, which I accept, that no one in her family skis, and that no one in her family has ever made any personal use of this condominium, nor was it ever intended that they should.
[15] As to the first of these three assumptions, it begs what I consider to be the real question in this appeal, which is whether the outlays in each year for interest, condominium fees, taxes, utilities and the like were made in order to produce a rental income in the long term or if they were made simply to preserve a trading asset. In view of my earlier finding, it is clear that these outlays were made for the latter purpose. It does not appear that the intention to treat the asset as inventory was ever abandoned by the Appellant or any other member of the group.
[16] The result, therefore, is that the owners, during 1993, 1994, and 1995, were precluded by section 10.1 and subsection 18(2) of the Income Tax Act from deducting interest or property taxes from their income except to the extent that the gross revenues in those years exceeded the other expenses in connection with the property.
[17] It follows that there can be no losses to deduct in those years, and that the excess of interest, taxes and other expenses beyond that which is required to reduce the income to zero in each year is an addition to the value of the unit as inventory. The Appellant and the other owners will, upon sale of the unit, or deemed sale, if that should take place, compute their profit or loss at that time on the basis of the historical cost, the additions to that cost of interest, taxes and other carrying costs to which I have just referred, and the net proceeds of any sale, or, in the case of a deemed sale, the then-market value.
[18] The appeals are therefore dismissed.
Signed at Ottawa, Canada, this 9th day of December, 1999.
"E.A. Bowie"
J.T.C.C.