Date: 19990520
Docket: 98-478-IT-I
BETWEEN:
MARY LOUISE STEPHENS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
BOWIE J.T.C.C.
[1] The Appellant was reassessed for income tax for the 1992 and 1993 taxation years, to disallow her claim that she is entitled to take her very substantial losses from a rental property into account in computing her income for those years under section 3 of the Income Tax Act (the Act). She takes the position that her house at 417 Mortimer Avenue, East York, (the Mortimer house) was a source of income, and that its losses should be included in the computation of income. She has appealed from these reassessments. The Minister of National Revenue (the Minister) takes the position that for the years under appeal she had no reasonable expectation of profit from that house, and that it was therefore not a source of income, and so its losses may not be taken into account.
[2] The law in this area is well settled. I must examine all of the facts disclosed by the evidence, and apply the criteria which have been established by which to determine whether or not there was a reasonable expectation of profit. If there was, then the Appellant is entitled to succeed. If there was not, then her appeals must fail. The Attorney General has pleaded in the Reply that the Appellant's expenses in connection with the property were unreasonable, and that they, or at least some of them, should therefore be disallowed under section 67 of the Act. It does not appear, however, that the Minister's assessor has troubled to make any analysis of the expenses as to their reasonableness. Nor are any particular expenses singled out in the Reply as being unreasonable.
[3] The Appellant inherited a seven-bedroom house on seven acres of land in Port Bruce in 1984. She rented it out from 1985 to 1989, at which time she sold it, because it was too far from her residence in Toronto, so that looking after it was difficult for her. She then looked for a rental property to buy in metropolitan Toronto, where she lives.
[4] The property which she purchased was the Mortimer house. It is a bungalow, which was said in the real estate listing to have two rooms in the basement. Under some pressure from a real estate agent, she bought this house without seeing the basement, with the intention, she said, of renting the main floor and the basement to separate tenants. She was surprised and disappointed, after taking possession, to discover that the two rooms she had been told were in the basement in fact consisted of one large room with a partial divider. The basement was not suitable for rental as a separate unit, and in fact she discovered, also after the purchase, that it would be contrary to the applicable by-law to rent the house as two separate units.
[5] By the time that the Appellant discovered these difficulties she had purchased the house, and she felt that she had little alternative but to make the best of her situation. She therefore rented the main floor, which had two bedrooms, for $890 per month. If I understood correctly, the basement remained empty initially, producing no income. During this period she and another person were living in a house elsewhere in the city, and sharing the rent. After about two years she decided to move into the basement of the Mortimer house, thereby saving herself the cost of paying rent elsewhere.
[6] The Appellant paid $209,000 for the Mortimer house. She paid $50,000 down, and the balance of $159,000 was financed by three mortgages. She was unsure of the interest rates payable on these, but the lowest seems to have been 10%. Her monthly interest payments for the mortgages alone amounted to at least $1,650 per month at the outset. She gave several different amounts during her evidence which she said were her expected monthly income, had she been able to carry out her original plan to rent the main floor and the basement as separate units. These ranged from a high of $2,000 to a low of about $1,550. None of these estimates seemed to be derived from a realistic view of the rental market in the neighbourhood. I do not believe that she had any knowledge of the rental market there, nor did she give evidence of having made any inquiries.
[7] It was suggested to me in argument that this is a case which should be viewed as one involving personal use by the taxpayer of the property, because by the time of the years under appeal she had moved into the basement of the house. She did this in an attempt to minimize her losses, however, and in my view it is appropriate to assess the reasonableness of her expectations on the basis that the house was, from the start, intended by her to be an investment. It must be assessed objectively, however. It is not sufficient for the Appellant to say, as she did, that it was her intention to rent the house at a profit for a period of time, and then sell it and buy a more expensive one, and continue in this pattern in order to acquire more and more valuable properties, and so provide herself with a retirement income.
[8] Turning to the criteria by which I must measure the prospect of profit, the most important one in the context of a rental property is the ability of the property, as financed, to produce a profit. Also important in the context of a rental property is the Appellant's planning, both at the outset and after the inability to produce a profit has appeared. It is well established that the courts should not be quick to second guess the business decisions of the Appellant, and that errors in judgment and unforeseen events causing losses should not lead inevitably to the conclusion that the taxpayer's rental property was not a source of income.
[9] In my view the Mortimer house, as financed by the Appellant at the time that she purchased it, never had the potential to produce profit as a rental property. It is true that she encountered some unexpected difficulties. Soon after she bought it she seems to have found herself faced with bills for some major repair and alteration work. She said in evidence, that in addition to the purchase price, she spent more than $20,000 on various items. She was not able to give any detailed account of what they were, but I accept that there were many things that needed to be repaired, and that she also spent a considerable amount in trying to make the basement into a rentable apartment. She also managed to pay off the third mortgage from an inheritance, but it is not clear to me whether she knew at the outset that these funds would become available to her, or if it was simply a windfall.
[10] Two things are clear, however. First, the Appellant made no proper investigation of either the house itself, or the real estate rental market in the neighbourhood before she purchased the property. If she had she would have seen immediately that this house, purchased on the terms that she agreed to, could not possibly produce a profit. Second, the Appellant learned very quickly after she acquired the house that it could not be operated at a profit. As soon as she learned that the basement had no income potential she must have realized that the income would not be sufficient to cover the expenses. By this time house prices were on the decline, and she was reluctant to sell at a loss. As a result she operated at an annual loss for the next several years. The net losses from this property during the seven year period from 1989 to 1995 were:
1989 $ 9,819
1990 $ 7,470
1991 $13,937
1992 $19,608
1993 $10,454
1994 $ 3,568
1995 $12,301
[11] In 1993 the interest expense alone attributable to the rental portion of the house was about one and one-half times the gross rental income. This appears to have been true of the years from 1989 to 1991 as well. In spite of these unrelenting losses, and her inability to do anything that would stem the tide, the Appellant apparently made no effort to sell the Mortimer house until 1998.
[12] This continuous history of losses is only one of the criteria to be applied by me in deciding whether this property is a source of income. I have considered the other criteria set out by the Federal Court of Appeal in Landry v. The Queen,[1] and I find that the Appellant did not have the degree of either training or experience which would enable her to turn this history of loss into a future of profit. So far as I can tell from the evidence before me, she did not adjust to the situation, or develop a plan to deal with it.
[13] The Appellant's agent likened this case to Costello v. The Queen.[2] However, in that case Judge Bowman found that the Appellant had gone about finding an investment property in a rational and businesslike way, and that her projections of income and expense were reasonable. Some unforeseen events, which were similar to some of those which befell Ms. Stephens, frustrated her immediate expectations. Nevertheless, the Appellant in that case, unlike Ms. Stephens, took corrective action, and by the time of the hearing she had brought the property back to profitability. In the present case, the most recent years for which I have evidence were not profitable, nor was I shown any course of action that might remedy that.
[14] In my opinion, even making generous allowance for the Appellant's misfortunes, and her poor judgment, and for the deceit that she says was practiced on her by those selling the property, there was not even a slight possibility, far less a reasonable expectation, in 1992 and 1993 that this property could produce a profit for the Appellant.
[15] The appeals are dismissed.
Signed at Ottawa, Canada, this 20th day of May, 1999.
"E.A. Bowie"
J.T.C.C.