Why you can't claim a rental loss when you give your adult children a cut-rate deal on rent
It’s not uncommon for parents to charge their adult children who still live at home below-market rent to help cover some of the household expenses and utilities. But if you think renting your home for a cut rate to non-arm’s length tenants will permit you to claim a rental “loss” on your tax return, a recent tax case may give you some pause.
The case, decided in January, involved a taxpayer from Newfoundland and Labrador who owned three properties. During 2011, he rented the properties at various times to his sons and incurred rental losses, which he proceeded to claim on his tax return to offset other income. The Canada Revenue Agency reassessed him, denying his claim for rental losses because the properties were not rented in pursuit of profit and, therefore, the activity does not constitute a source of income (or loss), but was instead a personal endeavour. The taxpayer appealed the CRA’s reassessment to the Tax Court.
This was not the taxpayer’s first time in court fighting perceived rental losses. Indeed, the Tax Court in 2014 concluded that similar rental arrangements between the taxpayer and his sons in 2009 and 2010 had “clear and considerable personal elements to them.” The court found the taxpayer’s reasons for his preference to rent to his own children were perfectly “acceptable and understandable,” but the rental properties “were simply a personal endeavour undertaken without the needed pursuit of profit” to constitute a source of income. The taxpayer further appealed that decision to the Federal Court of Appeal, and a 2016 decision agreed with the lower court’s findings and dismissed the appeal.
Although the taxpayer’s arrangements for these properties in 2011 were substantially the same as the arrangements in 2009 and 2010, the taxpayer claimed he had new evidence that would establish that these properties were, indeed, rented out at fair market value rents.
The first property was the home in which the taxpayer and his wife resided. It has a separate, one-bedroom basement apartment that he rented to one of his sons from January through April, 2011, for $350 per month. He allowed another son to rent a bedroom in the part of the house where the taxpayer and his wife lived and allowed that son to use the common areas, including laundry facilities, for a monthly rent of $300. The son paid that rent from January until June. From June 1, that son moved into a second and separate property, which he rented for $550. In each case, the rent paid by the taxpayer’s sons included all utilities.
The third property, acquired on Dec. 11, 2011, which was also rented to his son, was rented for only one week in 2011 at the agreed rental rate of $1,000 per month including utilities. In 2011, the total rent from this property was $250.
In order to demonstrate that the taxpayer was pursuing a profit in renting the properties to his sons so that he could claim rental losses, he needed to establish that he charged fair market value rents at each property. The taxpayer produced appraisals on each of the three properties, ostensibly obtained “to rebut the CRA’s appraisals.”
Yet the judge rejected the taxpayer’s appraisals, which simply contained estimates of the fair market value of each property in question by referencing comparable sales. They were not an assessment of fair market rents for the properties. Each appraisal contained a generic statement: “Market rent for the area in 2011 ranged from $(appropriate number) to $(appropriate number) per month (plus own utilities).” The judge found the appraisals problematic as they contained “no analysis or explanation of the basis or source of the statement regarding rental rates or the assumptions underlying it. The only analysis relates to comparable sales of properties.”
By contrast, the CRA’s appraisal reports were specifically aimed at identifying a fair market rental value for each property. In making those assessments, the CRA considered local vacancy rates, market data for comparable rentals (where available) and other factors. The judge found the CRA reports to be “more persuasive and clearly more appropriate for analyzing appropriate rental rates than the appraisals submitted by (the taxpayer).”
For example, the CRA report related to the one-bedroom basement apartment in the taxpayer’s home identified five one-bedroom units for rent in the same area with rents varying between $500 and $600 per month. On that basis, the CRA appraiser suggested a fair market value rental for the taxpayer’s basement apartment would be $500 to $550 per month, plus utilities.
The taxpayer argued that this rate was “too high,” but did not bring to court any persuasive evidence to support his claim. The judge concluded that charging his son $350 per month including utilities for the basement apartment was at least 30 per cent below the CRA’s determination of fair market rent and, therefore, constituted “below-market rent.” With respect to the space in the main residence rented to another son, the judge concluded that the taxpayer would not have provided the same space to anyone other than his son (or perhaps another very close relative). The taxpayer even conceded that if his son had been unable to pay rent, he would have allowed him to live in the home rent-free.
“(T)hese arrangements reflect two sons agreeing to help out with the costs of maintaining and running the home, given that they continued to reside there as adults, and two parents being happy to provide accommodation to their adult sons at below market rates because they are their sons,” the judge said.
In denying the rental losses, the judge concluded that none of the evidence the taxpayer provided with respect to the three properties suggested that they were a source of income in 2011. The taxpayer was simply “not pursuing a profit from the three properties,” the judge wrote. “Rather, the arrangements were dominated by personal relationships and the endeavour was a personal one.”