Date: 19981113
Dockets: 97-3283-IT-I; 97-3284-IT-I
BETWEEN:
MARC TURCOTTE, SOLANGE CREVIER,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard on common evidence under the informal procedure. The taxation years at issue are 1992 and 1994 for Mr. Turcotte and 1993 and 1994 for Ms. Crevier.
[2] The issue is whether the rental of a dwelling in the basement of the family home was a rental business, that is, a business operated for the purpose of making a profit.
[3] The facts on which the Minister of National Revenue (“the Minister”) relied in reassessing Mr. Turcotte are set out as follows in paragraphs 7, 8 and 9 of the Reply to the Notice of Appeal (“the Reply”), as follows:
[TRANSLATION]
7. In a notice of reassessment dated October 30, 1995, for the 1992 and 1994 taxation years, the Minister added $13,913 in additional income to the appellant’s income for the 1992 taxation year and $4,829 in additional income to his income for the 1994 taxation year, disallowing the losses previously allowed.
8. In making the reassessments dated October 30, 1995, for the 1992 and 1994 taxation years, the Minister considered the following facts, inter alia, to be true:
(a) during the taxation years at issue, the appellant and Solange Crevier (hereinafter “the spouse”) were equal co-owners of a property located at 1554 Des Chenaies in the municipality of Boisbriand in the province of Quebec (hereinafter “the property”);
(b) the property was acquired in 1988;
(c) the property is a single-family home with an apartment in the basement;
(d) the property has just one street address, namely the appellant’s address, 1554 Des Chenaies;
(e) the following income and expenses were reported in respect of the property for the 1992, 1993 and 1994 taxation years (a detailed account is appended hereto):
1992 1993 1994
Gross rental
income $4,275 $4,800 $4,920
Rental
expenses $19,805 $16,113 $14,578
Net rental
loss ($15,530) ($11,313) ($9,658)
(f) the appellant estimated that the basement took up one third of the total area of the property and said that the rental expenses he submitted represented one third of all the expenses for the property;
(g) the appellant claimed the following proportions of the total net rental losses for the property as his net rental losses: 100 percent for the 1992 taxation year, 0 percent for the 1993 taxation year and 50 percent for the 1994 taxation year;
(h) the following net losses have been reported in respect of the property since it was purchased:
Year Loss reported
1988 ( $7,788)
1989 ( $8,480)
1990 ( $8,634)
1991 ($24,914)
1992 ($15,530)
1993 ($11,232)
1994 ( $9,658)
(i) since the mortgage interest, property tax and insurance carrying charges alone totalled $7,536 for the 1992 taxation year, $7,622 for the 1993 taxation year and $7,409 for the 1994 taxation year, they exceeded the gross income by $3,261 in 1992, $2,822 in 1993 and $2,489 in 1994;
(j) during our audit, the appellant said that he knew he would not make a profit on this investment and that the only reason he rented his basement was to help pay the mortgage;
(k) the appellant filed no vouchers in support of his expense claims for the 1992 taxation year and filed only $3,000 worth of receipts for repairs for the 1994 taxation year, of each amount 50 percent was attributable to him;
(l) for the taxation years at issue, the appellant created an increase in his net rental loss by claiming capital cost allowance;
(m) the appellant has not shown that the sums of $13,913 for the 1992 taxation year and $4,829 for the 1994 taxation year were spent for the purpose of earning income from a business or property;
(n) during the taxation years at issue, the appellant had no reasonable expectation of profit in respect of his property.
9. The following facts were noted at the objection stage:
(a) the appellant could not provide the Minister with an action plan or profitability projections prepared before the property was acquired;
(b) the appellant did not provide vouchers for all the expenses for the years at issue;
(c) for the 1992 taxation year, the property tax expense submitted by the appellant represented 44 percent of the total property tax expenses for the property;
(d) the vouchers provided in relation to maintenance expenses and repairs were actually for personal expenses of the appellant for the taxation years at issue.
[4] The facts relied on in Ms. Crevier’s case are set out in paragraph 7 of the Reply. Since those facts are nearly the same as those applicable to Mr. Turcotte, I will reproduce only those that are different:
[TRANSLATION]
7. In making the reassessments dated October 30, 1995, for the 1993 and 1994 taxation years, the Minister considered the following facts, inter alia, to be true:
. . .
(g) the appellant claimed the following proportions of the total net rental losses for the property as her net rental losses: 0 percent for the 1992 taxation year, 100 percent for the 1993 taxation year and 50 percent for the 1994 taxation year;
. . .
(k) the appellant never filed any vouchers in support of her expense claims for the 1993 taxation year and filed only $3,000 worth of receipts for repairs for the 1994 taxation year, of which amount 50 percent was attributable to her;
. . .
(m) the appellant has not shown that the sums of $11,232 for the 1993 taxation year and $4,829 for the 1994 taxation year were spent for the purpose of earning income from a business or property.
[5] Ms. Crevier did not attend the hearing of her appeal. Mr. Turcotte testified. He admitted subparagraphs 8(a) to (c) and (e) to (l) of the Reply.
[6] The appellants purchased the property in 1988 for $185,000. The Minister’s officials were provided with the purchase agreement (Exhibit A-3) but never received the mortgage deed. In 1992, according to Exhibit A-6, the amount of the mortgage was $144,818.70 and the amount of interest paid was $15,488.84. That exhibit, as well as Exhibits A-4 and A-5, which were produced for the first time at the hearing, are annual statements drawn up by the lending financial institution. Exhibit A-5 shows that, in 1993, the principal balance was $142,999.34 and the amount of interest paid was $13,747.21. Exhibit A-4 relates to 1994 and shows that the balance was $140,646.75 and that the amount of interest paid was $11,974.95.
[7] When the house was purchased, there was an apartment in the basement (Exhibit A-3). When the apartment was rented, it brought in an average of $400 a month. Exhibit A-2 consists of two leases: one for the period from July 1, 1990, to June 12, 1991, and another for the period from February 15, 1992, to June 30, 1994.
[8] At the beginning of the investigation by the Minister’s officials, the appellants explained that their mortgage had remained so high because of hidden defects that had existed when they purchased the house. They said that they had had to sue the contractor, who had gone bankrupt, and that they had had to pay for $80,000 worth of work. At the hearing, Mr. Turcotte admitted that the appellants had not had to pay that amount.
[9] Exhibit A-1 consists of various documents relating to the lawsuit brought by the appellants against the contractor to have the hidden defects in the house repaired. It also contains a settlement document in which the contractor agreed to do the work and to do so at its own expense. However, there is no document proving that the contractor went bankrupt or, above all, that the appellants had to pay $80,000 for the repair work.
[10] Johanne Desjardins, one of the Minister’s officials, testified at the request of counsel for the respondent. She filed as Exhibit I-4 a recent real estate company advertising document containing a number of photographs of houses for sale. The appellants’ house is one of them. There is no reference to an apartment in the basement. She called the real estate agent, who had no idea that there could be an apartment in the basement. He told her that there was a nicely finished recreation room in the basement. There were not two addresses, but only one.
[11] The insurance documents for 1993 to 1995 were filed as Exhibit I-3. They refer to the property as an owner-occupied principal residence. There is no reference to a tenant in the basement of the home. The address 1554A is mentioned, but in connection with the use of an office attached to the principal residence.
[12] The statements of account for municipal and school taxes were filed as Exhibits I-1 and I-2. Exhibit I-1 shows that there was a second dwelling in 1991 and 1992 for water tax purposes. In 1993, there were no longer two dwellings listed, but only one. In fact, an additional assessment notice was sent in that regard. The same is true for the following years, up to 1998. Exhibit I-2 shows that, in 1989, 1990, 1991 and 1992, Ms. Crevier paid business tax for a computer-related business she operated there.
[13] Counsel for the respondent relied on the Federal Court of Appeal’s decision in Mohammad v. The Queen dated July 28, 1997, and in particular the following passages:
. . . On the facts of this case, the interest component of the rental expenses was itself sufficient to create a loss even though revenues had not fallen below the taxpayer’s expectations.
. . .
. . . This is not a case where revenues fell below expectations. This is a case where the taxpayer could not reasonably expect to generate a profit until such time as the principal amount of the outstanding purchase-money indebtedness was reduced accordingly.
. . .
. . . 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.
[14] In the instant case, some doubt was raised at the hearing as to whether the basement was actually rented during the years at issue. Even if we accept that it was rented, the evidence has clearly shown that the rental property in question could not generate profits as capitalized. The carrying charges made up of the mortgage interest, property taxes and insurance costs exceeded the gross income by almost half. The appellants referred to the possibility that the mortgage interest would have been reduced quickly if it had not been for the repair work necessitated by a hidden construction defect, which repairs allegedly cost them $80,000. However, they adduced no evidence of such payment.
[20] Accordingly, the appeals are dismissed.
Signed at Ottawa, Canada, this 13th day of November 1998.
“Louise Lamarre Proulx”
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]