Date: 20010914
Docket: 2000-665-IT-I
BETWEEN:
ANNA P. DEFREITAS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor Judgment
Miller, J.T.C.C.
[1] These appeals by Anna Defreitas by way of informal procedure are against the Minister's reassessments for 1995, 1996 and 1997. The Minister is disallowing the deduction of rental losses for those years in connection with properties in which Ms. Defrietas resided. The Appellant framed the issue as is usual for these cases as follows:
(a) Did the Appellant have a reasonable expectation of profit?
(b) If so, were the disallowed expenses deductible in accordance with subsection 18(1) of the Act?
The Respondent concurred with this approach.
[2] The Appellant purchased 94 Fenelon Drive, North York in 1990, financing the purchase with a mortgage of $160,000. The Appellant indicated that her objective in acquiring the Fenelon property was twofold: to provide a principal residence, and to earn "large sums of income". She testified that she eventually wanted to retain Fenelon as a stand alone rental property and not as a principal residence.
[3] The Fenelon property was a three bedroom house with a partially finished basement. The basement consisted of a bedroom, sitting room and a kitchen, though the Appellant described this more as a servery as it had no stove or fridge. The Appellant rented the basement from 1990 and 1996 at a gross income and rental loss as follows:
|
Year |
Rental Income |
Rental Loss |
|
1990 |
$750 |
$3,115 |
|
1991 |
$6,000 |
$7,280 |
|
1992 |
$4,000 |
$11,039 |
|
1993 |
$4,800 |
$5,768 |
|
1994 |
$4,800 |
$8,047 |
|
1995 |
$4,800 |
$4,570 |
|
1996 |
$2,850 |
$4,249 |
[4] The Appellant lived upstairs in the Fenelon property. The arrangement with the basement tenant was very much a shared arrangement. The tenant had access to all of the main floor other than the Appellant's bedroom and bathroom. The tenant also provided furnishings not only for the basement but also for the upstairs kitchen and family room. The tenant had the use of the garage as the Appellant stated the tenant was around more than the Appellant herself, whose job required that she travel 30-50% of her time. Ms. Defreitas also testified that because her husband died in the house in 1992 she wished to spend as little time there as possible. Consequently she tended to work late and not go home. Her intention was to significantly reduce the mortgage quickly so she could start earning her profits. The $160,000 mortgage had been reduced to $98,000 by 1994 and to $54,000 by May, 1997 when the Appellant sold the property. She sold the property for approximately $220,000. No amount of gain was reported as a taxable capital gain, though it was suggested that after deducting agent's fees and other costs, there was no actual gain realized.
[5] Throughout the years of ownership of the Fenelon property Ms. Defreitas had advertised for tenants by word of mouth, advertising at her place of work and at the place of work of family members, advertising at the local church and grocery store and, on one occasion, advertising in a Toronto paper. She checked references and conducted credit checks. As a single woman after 1992 she indicated that she had to feel comfortable with a tenant before entering an arrangement. Her tenant in 1995 and 1996 paid rent of $400 a month and in the last couple of months, $425 Ms. Defreitas had wanted to charge more but recognized that was all the tenant could afford and she felt she would prefer a steady paying tenant at $400 a month than a new potentially riskier arrangement at a higher rent. When this tenant moved out in 1996 she experienced some difficulties in finding a new tenant, but eventually found a co-worker, a Mr. Edwards, who with his two children agreed to rent the basement. Mr. Edwards also required an office. It became clear to the Appellant that she should find something bigger with potentially greater profit capability.
[6] The expenses on the Fenelon property which were not accepted by the Minister as legitimate operating expenses in 1995 and 1996 were cable and television expenses and certain repairs and maintenance. Ms. Defreitas maintained that the cable and television was part of the rental agreement, though she had no proof of the expenditure. Revenue Canada had indicated in Exhibit A-1 however that it had reviewed vouchers for such expenditures. With respect to the disputed maintenance and repairs on the Fenelon property, in 1995 these consisted of new aluminum soffit, fascia and eavestrough of $1,260, and in 1996 of $1,000 for ripping up carpet and repainting the floors due to damage from the tenant's dog, and $346 for a saw required for the job.
[7] In May, 1997 the Appellant bought a property at R.R. 4, 16865 Caledon King, Tottenham for $282,000. This property was a three bedroom bungalow with a partially finished basement of two bedrooms. There was also a barn and swimming pool on a ten acre lot. The Appellant's intention was that this property would serve as her principal residence as well as a shared accommodation with Mr. Edwards and family. She also planned to finish the basement for further rental space, and also fix up the barn to board horses. She did some investigation into the business of boarding horses and determined she could do so under an arrangement which would not require her personally to care for the horses. She believed she could obtain $300 - $500 a month per horse.
[8] As the premises had been vacant for four years and given the Appellant's plans for future rental accommodation, the Appellant engaged a contractor to do major renovations. The Appellant had budgeted approximately $90,000 for the renovations, and an additional $10,000 for a new roof. The hiring of the contractor however was the start of some serious problems for the Appellant. The contractor removed the roof and poured some foundations for an extension. Then two things happened which were unexpected. First, the contractor left, with a $51,000 deposit from the Appellant in hand. Second, and almost coincidentally within two or three weeks of work having started, a severe storm ripped the tarpaulin off the premises and created serious water damage throughout the house. The Appellant described the damage as extensive; the finished basement was completely ruined, and walls had in fact buckled. While the Appellant had intended on renovations of approximately $100,000 including a new roof, she was now in a position of having lost $51,000 to a contractor, and having to pay for not only a new roof, as originally anticipated, but also repairs of substantial water damage. As well, the contractor had mislaid the foundation which would require moving and doing over. Of the approximate $17,300 in repairs and maintenance expenditures claimed in 1997 on the Caledon property, approximately $9,900 was in connection with the roof and $7,400 was for the repairs of the water damage. There was some confusion as to whether the latter amount included re-doing some of the foundation. No receipts were provided at trial to clarify the breakdown of this amount, though Canada Customs and Revenue Agency vouched the total of $17,345.18.
[9] Due to the problems with this property the Appellant actually moved out of the property for a few months. She described this period of her life as a "horrifying experience". She ran out of available credit to complete all the required repairs and renovations. To this day, the basement and barn have not been made suitable for rental purposes.
[10] Mr. Edwards continued to live in the property, but at a reduced rate of $500. per month. That rate doubled to $1,000. in late 1998. As with the Fenelon property, the tenant had access to all of the house other than Ms. Defreitas' personal bedroom and bathroom. Mr. Edwards also had exclusive access to a room serving as his office in addition to two bedrooms and his own bathroom.
[11] The anaylsis of an appeal involving the denial of rental losses arising from a personal residence commences with the review of Moldowan v. The Queen, 77 DTC 5213. My understanding of Moldowan in its application to these cases is that, unless the rental operation viewed objectively has a reasonable expectation of profit, it will not be considered a source of income as required by section 3 of the Income Tax Act ("Act") and therefore not subject to any further application of the Act. Notwithstanding some criticism, some tinkering and even some confusion with respect to this principle, until there is a clear authoritative decision to the contrary I will view Moldowan as part of the gatekeeping approach, section 3 of the Act itself being the gatekeeper. If objectively there is a reasonable expectation of profit, the taxpayer enters the gate and is subject to the application of the other provisions of the Act to determine whether the actual expenditures were personal or living expenditures (paragraph 18(1)(h)) and if not then if incurred for the purpose of gaining or producing income (paragraph 18(1)(a)). At that point it is finally necessary to determine if such expenditures are reasonable as required by section 67 of the Act.
[12] In applying the reasonable expectation of profit test I must first determine whether the test is applied based on the actual claimed expenditures of the taxpayer or on what a reasonable commercially-minded landlord would have claimed as legitimate expenditures. I intend to follow the latter approach. In doing so, it quickly becomes apparent that the issue of reasonableness and purpose become jumbled together in the application of the reasonable expectation of profit test. To view Ms. Defreitas' rental operation objectively, I accept an allocation of the personal portion attributed to both the Fenelon property and the Caledon property expenses as fifty percent. The Appellant's evidence was that the tenants of the Fenelon property enjoyed access to all parts of her home except her private bedroom and bathroom. There were times that the tenant used the garage rather than the Appellant. With respect to the Fenelon property, due to the emotional ties which clearly caused her some distress, she spent as little time as possible there. Her job required extensive travelling from Toronto. She simply was not there much. In connection with the Caledon property, again her evidence was that it was a true sharing arrangement as far as the use of the property went. The tenant, Mr. Edwards and his two children had full access to the house; as well, Mr. Edwards had exclusive access to a room which served as his office. In the Caledon property, due to the significant problems with the contactor, compounded by the severe weather damage, the Appellant actually moved out for a period of time, moving into her mother's place, while the tenant remained in the property. With respect to both properties the evidence was that shared rooms were furnished similarly on a shared basis, both the landlord and tenant contributing furnishings. This all leads me to the conclusion that both properties were shared on an equal basis and the appropriate allocation of personal use is fifty percent.
[13] For purposes of this objective analysis of the reasonable expectation of profit, I am going to rely on the accepted expenses set forth in Exhibit A-1, items 4 and 5 for 1995 and 1996 respectively, while for 1997 I suggest a reasonable figure would be $2,500 higher than indicated in Exhibit A-1, item 6 (see attachments reproducing items 4, 5 and 6). Acceptable expenses in 1997 did not include anything for maintenance and repairs although the Appellant claimed approximately $17,000. This is a larger property in a rural setting and in the ordinary course some maintenance and repairs would be essential. Given that the Minister accepted amounts of $1,000 and $2,000 approximately for the smaller property in 1995 and 1996, an annual figure of $2,500 is a reasonable repair and maintenance expense for the large property in 1997. The reasonable expenses for these properties, for purposes of evaluating the reasonable expectation of profit are therefore as follows (in approximate amounts):
|
1995 |
1996 |
1997 |
|
|
Reasonable expenses |
$12,500 |
$11,750 |
$19,300 |
|
Less 50% personal allocation |
$6,250 |
$5,875 |
$9,650 |
|
Expenses attributable to income from property |
$6,250 |
$5,875 |
$9,650 |
[14] Ms. Defreitas never achieved income from the Fenelon property in excess of $4,800 a year though she indicated that prior to selling the Fenelon property, her rent increased to $425 which would yield $5,100 a year. This comes very close to covering the reasonable expenses in 1996. Given the history of paying down the mortgage with the consequent reduction in interest expense (from 1995 to 1996 the interest payments went down by $1,500), I find there was a reasonable expectation in the 1995 and 1996 years of a possible profit in the not too distant future.
[15] In 1997, the combination of a potential $1,000 a month accommodation rental income and $500 a month for boarding horses, could yield gross income of as much as $18,000 a year as against reasonable expenses for 1997 of $9,650. This factor combined with the Appellant's ability to pay down a mortgage and her motivation to make money leads me to conclude there was indeed a reasonable expectation of profit in 1997 prior to disaster striking.
[16] Having determined that there is a source of income from property in the years in question, it is necessary to now apply section 18(1) and section 67 of the Act in making two further inquiries. Firstly, were the expenses incurred for the purpose of gaining or producing income as opposed to being incurred as personal living expenses? And, secondly, if so, were such expenses reasonable? The definition of personal or living expenses reads:
248 (1) "personal or living expenses" includes
(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,
[17] To be included as personal or living expenses the property expenses must be for the Appellant's benefit and must have been incurred not in connection with a business with a reasonable expectation of profit. The Appellant claimed sixty percent of the property expenses in 1995 pertained to a non-personal use. I have already determined that only fifty percent of such expenses were reasonably attributable to the non-personal use; that is, fifty percent of the property expenses were not for the benefit of the Appellant and therefore not personal or living expenses. Having reached that conclusion it is unneccesary to consider the latter half of the definition of personal or living expenses. Similarly in 1996 and 1997 fifty percent of the property expenses were not personal or living expenses. I further find that the reason the Appellant incurred fifty percent of the property expenses in all three years was to earn income from the properties. While the effect of incurring these expenses was to defray some of the personal costs of her residence, I am satisfied that the Appellant's purpose with respect to both properties was to generate income. She was well on her way on the Fenelon property by her rapid reduction of her mortgage, and was likewise facing a potentially profitable situation with the Caledon property before encountering her unforeseen problems.
[18] Finally, I must review the reasonableness of the expenditures in all three years. In 1995 the Appellant's claimed expenses included $1,260 for soffit, fascia and eavestroughing: as these were not shown to be repairs only but replacement costs, I find them to be capital expenditures. With respect to $734.06 of cable and television expenses, there was insufficient evidence to attribute these to the non-personal use. For 1995 therefore I allow the vouched expenses less $1,260 and less $734.06, multiplied by a factor of fifty percent. That results in deductible expenses of $6,250.65 creating a loss of $1,450.65.
[19] In 1996 I allow the vouched expenses less an amount of $899.48 for cable and television (for reasons stated above) and less $346 for the purchase of a saw, again, multiplied by the factor of fifty percent. That leaves $6,388.20 of deductible expenses creating a loss of $3,538.20.
[20] In 1997 the Appellant claimed $16,095 as maintenance and repairs, while Canada Customs and Revenue Agency actually vouched $17,345.18. Of this, approximately $8,615 plus provincial sales tax and goods and services tax for an approximate total of $9,906 pertained to a new roof, and the balance was for the repair of water damage resulting from the storm and for more concrete foundation work. There was no breakdown of the balance of the repairs between water damage and the foundation; the former being current expense and the latter being a capital expenditure. Without such guidance I limit the repair expense to the reasonable estimate I relied upon earlier of $2,500. I therefore allow vouched expenses less an amount of $1,156.48 for cable and television and less $14,845.18 for unreasonable or non-qualifying repair expenditures, again multiplied by the fifty percent factor. That leaves deductible expenses of $9,655.45 creating a loss of $3,655.45.
[21] I allow the appeal and refer the reassessments back to the Minister on the basis that losses be allowed in the amounts of $1,450.65, $3,538.20 and $3,655.45 respectively for 1995, 1996 and 1997.
Signed at Ottawa, Canada this 14th day of September, 2001.
"Campbell. J. Miller"
J.T.C.C.
Exhibit 1, Item 4
|
EXPENSES |
CLAIMED PER T776 |
REVIEWED YES/NO |
AMOUNT VOUCHED |
VOUCHED NOT ACCEPTABLE |
ACCEPTABLE EXPENSES |
|
PROPERTY TAXES |
$ 2,164.77 |
YES |
$ 2,164.77 |
$ - |
$ 2,164.77 |
|
MAIN & REPAIRS |
$ 2,810.22 |
YES |
$ 2,314.29 |
$ 1,260.00 |
$ 1,054.29 |
|
INTEREST |
$ 6,992.21 |
YES |
$ 6,153.84 |
$ - |
$ 6,153.84 |
|
INSURANCE |
$ 424.83 |
YES |
$ 369.42 |
$ - |
$ 369.42 |
|
CONDO FEES |
$ - |
$ - |
|||
|
LIGHT/HEAT/WATER |
$ 3,640.34 |
YES |
$ 3,493.03 |
$ 734.06 |
$ 2,758.97 |
|
ADVERTISING |
$ - |
||||
|
OTHER (specify below) |
$ - |
||||
|
TOTAL |
$ 16,032.37 |
$ 12,501.29 |
|||
|
Less: Personal Portion |
$ 6,661.74 |
$ 6,250.65 |
|||
|
Net Expenses |
$ 9,370.63 |
$ 6,250.65 |
|||
|
NET RENTAL LOSS |
$ (4,570.63) |
||||
|
OTHER: |
GROSS RENTAL INCOME |
$ 4,800.00 |
|||
|
EXPENSES ALLOWABLE |
$ 4,800.00 |
||||
|
REVISED NET RENTAL INC. |
NIL* |
||||
Exhibit 1, Item 5
|
EXPENSES |
CLAIMED PER T776 |
REVIEWED YES/NO |
AMOUNT VOUCHED |
VOUCHED NOT ACCEPTABLE |
ACCEPTABLE EXPENSES |
|
PROPERTY TAXES |
$ 2,176.00 |
YES |
$ 2,188.54 |
$ - |
$ 2,188.54 |
|
MAIN & REPAIRS |
$ 3,683.57 |
YES |
$ 3,295.21 |
$ 1,346.00 |
$ 1,949.35 |
|
INTEREST |
$ 4,992.58 |
YES |
$ 4,882.59 |
$ - |
$ 4,882.59 |
|
INSURANCE |
$ 398.97 |
YES |
$ 398.97 |
$ - |
$ 398.97 |
|
CONDO FEES |
$ - |
$ - |
|||
|
LIGHT/HEAT/WATER |
$ 2,947.34 |
YES |
$ 3,256.43 |
$ 899.48 |
$ 2,356.95 |
|
ADVERTISING |
YES |
$ - |
$ - |
||
|
OTHER (specify below) |
$ - |
||||
|
TOTAL |
$ 14,198.46 |
$ 11,776.40 |
|||
|
Less: Personal Portion |
$ 7,099.24 |
$ 5,888.20 |
|||
|
Net Expenses |
$ 7,099.22 |
$ 5,888.20 |
|||
|
NET RENTAL LOSS |
$ (4,249.22) |
||||
|
OTHER: |
GROSS RENTAL INCOME |
$ 2,850.00 |
|||
|
EXPENSES ALLOWABLE |
$ 2,850.00 |
||||
|
REVISED NET RENTAL INC. |
NIL* |
||||
Exhibit 1, Item 6
|
EXPENSES |
CLAIMED PER T776 |
REVIEWED YES/NO |
AMOUNT VOUCHED |
VOUCHED NOT ACCEPTABLE |
ACCEPTABLE EXPENSES |
|
PROPERTY TAXES |
$ 3,740.05 |
YES |
$ 3,740.05 |
$ - |
$ 3,740.05 |
|
MAIN & REPAIRS |
$ 16,095.00 |
YES |
$ 17,345.18 |
$ 17,345.18 |
$ - |
|
INTEREST |
$ 9,331.65 |
YES |
$ 9,328.11 |
$ - |
$ 9,328.11 |
|
INSURANCE |
$ 480.00 |
YES |
$ 369.96 |
$ - |
$ 369.96 |
|
CONDO FEES |
$ - |
$ - |
|||
|
LIGHT/HEAT/WATER |
$ 4,952.14 |
YES |
$ 4,529.26 |
$ 1,156.48 |
$ 3,372.78 |
|
ADVERTISING |
$ - |
$ - |
$ - |
||
|
OTHER (specify below) |
$ - |
||||
|
TOTAL |
$ 34,598.84 |
$ 16,810.90 |
|||
|
Less: Personal Portion |
$ 17,299.43 |
$ 8,405.45 |
|||
|
Net Expenses |
$ 17,299.41 |
$ 8,405.45 |
|||
|
NET RENTAL LOSS |
$ (11,299.41) |
||||
|
OTHER: |
GROSS RENTAL INCOME |
$ 6,000.00 |
|||
|
EXPENSES ALLOWABLE |
$ 6,000.00 |
||||
|
REVISED NET RENTAL INC. |
NIL* |
||||
COURT FILE NO.: 2000-665(IT)I
STYLE OF CAUSE: Anna P. Defreitas v. The Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: July 31, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge Campbell J. Miller
DATE OF JUDGMENT: September 14, 2001
APPEARANCES:
Agent for the Appellant: David G. Masters
Counsel for the Respondent: Kelly Smith Wayland
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-665(IT)I
BETWEEN:
ANNA P. DEFREITAS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on July 31, 2001 at Toronto, Ontario by
the Honourable Judge Campbell J. Miller
Appearances
Agent for the Appellant: David G. Masters
Counsel for the Respondent: Kelly Smith Wayland
JUDGMENT
The appeals from the reassessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada this 14th day of September, 2001.
|
"Campbell J. Miller" |
J.T.C.C.