Owning a rental property can be a lot of work, and, in some cases can generate annual losses, depending on how high your expenses are compared with the amount of rent you are able to charge. In most cases, however, the sting of such rental losses can be somewhat lessened if you can deduct those rental losses against other income, reducing your tax payable by up to 54 per cent, depending on your province, level of income and marginal tax rate.
Keep in mind, however, that for rental losses to be tax deductible, the property must be rented out for the purpose of earning income. A recent tax case, decided last month, involved a taxpayer who wrote off rental losses for the 2015, 2016 and 2017 tax years in connection with a property he owned in Wiarton, Ont., that he said he rented out to his mother.
The taxpayer reported gross rental income from the property of $7,200 in each of 2015 and 2016, and $7,000 in 2017. His mother didn’t pay for utilities or other expenses throughout her tenancy.
The taxpayer’s expenses in each year for insurance, maintenance and repairs, property taxes, travel, telephone and utilities and other expenses totaled $21,512, $24,819 and $17,693 in each of 2015, 2016 and 2017, respectively. This resulted in rental property losses of $14,312, $17,619 and $10,693 in each of the taxation years, respectively.
But the Canada Revenue Agency, in the judge’s words, was “having none of this,” and the taxpayer was reassessed to disallow all expenses related to the rental property, and to reduce his rental income in each year to zero. The primary basis for the CRA’s reassessment was that the property was not a rental property and that the taxpayer had no source of income. With no source of income, expenses cannot be deducted.
Was there a source of income? The legal test to determine whether a taxpayer has a source of income from a property stems from a 2002 Supreme Court of Canada case. That case struck down the old “reasonable expectation of profit test” and concluded that where there is no personal element to a particular activity and the activity was carried out in a sufficiently commercial fashion, then a taxpayer should be permitted to deduct his or her expenses relating to that activity, even if it creates a loss.
In the current case, the court needed to determine if there was a personal element to the taxpayer’s arrangement, being that the property was rented to his mother, and whether the taxpayer “manifestly intend(ed)” to make a profit from his rental activity by embracing “objective standards of commercial-like behavior.”
The property was originally owned by the taxpayer and his ex-wife, but when his marriage broke down, the taxpayer became the sole owner of the property. His mother began living in the property seasonally in 2012, and then full-time starting in 2014.
The property itself was in disrepair. The taxpayer, a contractor and electrician by trade, improved the electrical, replaced the hot water tank, fixed cracks in the walls, did some painting and installed windows and new lights. His mother occupied one bedroom and the living areas of the home, while the second bedroom was used by the taxpayer for storage of tools, paint and other renovation supplies. During periods of renovation, mostly on weekends since the taxpayer had a full-time day job during the week, the taxpayer would often sleep on a mattress in this second bedroom.
In April 2014, the taxpayer described a “catastrophe” which involved severe leakage and seepage of external groundwater into the basement of the property and required external excavation, foundation repair, installation of weeping tile and landscaping. Although the remediation and reconstruction were considerable, and most would consider the property uninhabitable during the period, his mother continued to live at the property during the entire time.
The taxpayer testified that the below-market rent of $600 per month that he charged his mother during the three years in question was reflective of “an adaptive business response” which, in most other cases, would have resulted in the property being vacant.
Ultimately, when the taxpayer’s mother passed away in 2021, the property remained vacant and was never rented again to a third party. In 2024, the taxpayer himself moved into the property and it remains his principal residence to this day.
The taxpayer argued that the property was a venture undertaken in pursuit of profit and not a personal endeavour. His mother, as the only tenant, the catastrophic flood, and the need for extensive renovations were merely “unfortunate circumstances which otherwise obscure the business nature of the rental property and its generation of a source of income.”
The judge, in reviewing the evidence, noted “certain deficiencies and oddities” on the rent receipts, such as the rent being paid in cash, and the receipts being unsigned. In addition, after the taxpayer’s mother passed away, no other tenant ever lived at the property and it remained vacant for three years after being fully renovated and, presumably, able to be easily rented.
In the end, the judge suggested that the taxpayer’s “arrangement, while quite laudable and loving, is not a business venture undertaken in pursuit of profit. Instead, it was quite personal.” It essentially involved providing, in the short term, housing for the taxpayer’s elderly mother with an appropriate level of cost sharing and, longer term, a renovation project to remodel the house for the taxpayer’s subsequent primary residence.
Since it was a personal endeavour, the judge concluded, it cannot otherwise be transformed into a business venture. The judge therefore disallowed the taxpayer’s rental losses on the basis that the property did not generate a source of rental income from the property, and as such, none of the expenses or capital costs could be deducted or depreciated because no source of income exists.