The Tax Court finds no source of income in a case involving a taxpayer claiming “rental losses” over a few years. Although the properties were clearly investment properties, the taxpayer did not act in a business-like manner to show that rental is a source of income.
Tax practitioners must be wary of rental losses claimed by clients whose goals are simply to maintain the property and get something out of it rather than nothing. As practitioners you need to ask, is my client acting in a business-like manner? Do they have lease agreements with arm’s length terms? Are they charging rent at market rates? If the market justifies a rent increase, why are my clients not increasing rents to cover expenses?
Mr. Hustak owned two rental properties in Ontario. He claimed to have charged rent below fair market value for four reasons: due to high rental vacancies rates, to attract tenants, his insurance company advised him if the properties remained vacant they would not cover him, the tenants expressed an interest to purchase the respective properties.
Mr. Hustak found tenants by putting a sign on the property to be leased and by advertising in the local newspaper.
Tenants paid for utilities. Mr. Hustak’s primary objective was to recover the interest portion of the mortgage payments, the property taxes and the insurance costs to ensure that the properties were not vacant to maintain the insurance coverage
Issue Before the Court
Is Mr. Hustak’s rental operation a source of income?
The Tax Court of Canada (TCC) held that Hustak’s rental operation is not a source of income. Mr. Hustak was not able to show that he conducted his rental activities in a commercial manner with a view to make a profit.
The court relied on precedents set in Stewart v. Canada, 2002 SCC 46 :
the issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question. Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary. Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income. . . .
The court sought to answer two questions:
- Did Mr. Hustak’s intend to carry on an activity for profit and is there evidence to support that intention?
- Did he establish that his predominant intention is to make a profit from the activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour?
For the following reasons, the court found that Mr. Hustak’s was not able to show that his predominant intention was to make a profit:
- Mr. Hustak intended only to recover the cost of certain expenses and to maintain insurability.
- Mr. Hustak rented out one of the properties to a family member for below the fair market value and well below the rent charged to the other tenants.
- He did not act in a business-like manner: He had no actual leases with his tenants, made no attempt to determine the comparable rent in the area, and failed to increase the rents over the years despite the significant expenses he incurred.
Interestingly, putting a sign on the property to be leased and by advertising in the local newspaper were not enough to establish commerciality.