27 April 1998 Internal T.I. 9725406 - rental loss when held as adv nat trade

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

carrying costs in excess of rental income on property held primarily for resale, either as an adventure in the nature of trade or as a capital asset

Position:

carrying costs in excess of rental income not deductible unless there is a reasonable exp of profit from the rental operation - if no reasonable expectation of profit and on an adventure in the nature of trade, the excess carrying costs are capitalized or, if held as a capital asset, the excess is only capitalized to the extent permitted by s 53

Reasons:

rental operation is separate from the holding of property for resale -jurisprudence supports a denial of the carrying costs in the year if there is no REOP from rental - judicial support for the capitalizing of excess carrying costs because of the truer picture analysis and the fact that the recommendation for accounting for real estate trades recommends capitalization

		April 27, 1998
	Art Gowling, Director	HEADQUARTERS
	Verification Division, VECR	A. Humenuk
	Attention:  Joanne Sluzar
		972540

Rental Losses on Property Held Primarily for Resale

This is in response to your memorandum of September 18, 1997, concerning the deductibility of expenses incurred in excess of rental income earned from a property held primarily for resale.

The issue is whether the amount by which the annual carrying costs of a property exceeds any rental income earned therefrom in the year is deductible in computing a taxpayer’s income where the property was acquired as an adventure in the nature of trade and there is no reasonable expectation of a profit from the rental of the property.

It is our view that a rental operation and the holding of property for resale as an adventure in the nature of trade should be viewed as separate activities for income tax purposes. Accordingly, any excess of expenses over rental income for a particular year is only deductible in computing income from property in the year if the individual has a reasonable expectation of profit from the rental operation. Jurisprudence supporting this position includes Ayoub v. the Queen (1996 D.T.C. 3300), Deluca et al. v. the Queen (96 D.T.C. 3235), McPherson et al. v. the Queen (1997 D.T.C. 1497). In these cases, the losses were denied because the taxpayer’s profit expectations rested solely on the potential resale value of the property. In Russell v. the Queen (1995 E.T.C. 85), the court made a clear distinction between property held for resale and property held for rental purposes. Carrying costs for the period in which the property was held for resale were not deductible but losses for the period during which the taxpayer had a reasonable expectation of income from the rental operation were deductible. We have enclosed a copy of the Russell decision as it is only available in electronic format (cited E.T.C.).

When the carrying costs of real property held as inventory exceeds the rental income for a particular year and there is no reasonable expectation of profit from the rental operation, it is our view that the excess carrying costs must be capitalized for the reasons stated in Stein v. the Queen (96 D.T.C. 1526). In the Stein decision, it was noted that the capitalization of carrying costs is a well-accepted business principle for a real estate trading business and provides a truer picture of the income of the taxpayer. If the property is held primarily for capital appreciation and not as part of an adventure in the nature of trade, the carrying costs are neither deductible in computing income nor capitalized except to the extent permitted by subsection 53(1) of the Act.

It must be emphasized that the determination of whether a particular rental operation has a reasonable expectation of profit is a question of fact and each case must be looked at separately. Should you require assistance with a particular fact situation, please do not hesitate to contact us.

Finally, we note that any excess of carrying costs over rental income earned in respect of property which was primarily acquired or used for a personal purpose, such as a potential vacation retreat, a future residence, property which is rented to an arm’s length tenant or property which was converted from a personal use because of a change in circumstances, would not generally be deductible in computing a taxpayer’s income for the year. In this regard, we note that, in Blanchet v. the Queen, (1996 D.T.C. 3209), in which the issue was the appropriate proportion of expenses considered to be personal in a shared accommodation situation, the court held that there was no reasonable expectation of profit but was precluded from further decreasing the taxpayer’s loss (and increasing tax payable) as a result of the appeal process.

P. Spice
Business, Property and Employment Section III
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
Enclosure

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