The losers

Monday we discussed the poor schmucks who bought condos as ‘investments’. Some of them thought they could flip before closing, making a fortune. Others figured they could rent and enjoy a healthy income stream, letting a tenant ‘pay the mortgage’ for them.

This is not a small crowd of losers. It’s huge.

Urbanation has estimated 50% of all condo purchasers in Toronto (and similar numbers exist in Vancouver) were not end-users. In fact, one in five families in the GTA are multiple-property owners, most of those places being rental apartments. Without this pool of units, of course, vacancy rates would crash and rents rise more.

But nobody who rents believes that. Or the undeniable fact landlords subsidize tenants. So, as a consequence, everybody hates these folks. They’re called speculators, or worse – like greedy, rapacious, dirtbag, leeching scum. You get the picture.

Well, most of these folks are losing money every month. Condo values are falling. Inventory is soaring, and they can’t get out.

For the CRA, they’re also sitting ducks. Quack, quack. Blam, blam.

Regular addicts may recall we reported the revenuers are carefully looking at under-water, negative-cash-flow condo owners who claim these losses against rental or other income. The idea of having a business (and owning a rental condo or two is a business activity) is to make a profit. That profit is then subject to tax. Therefore the government expects everyone buying and holding a unit to rent out should have a reasonable expectation of profit.

If it’s clear that’s never gonna happen – which is largely the current situation – why should the taxpayers eat their loss?

Blog dog Sikandar sees it otherwise. “I think that CRA disallows losses if rentals are below market value only,” he says. And he sends a CRA link which states: “You have a rental loss if your rental expenses are more than your gross rental income. If you incur the expenses to earn income, you can deduct your rental loss against your other sources of income.”

That seems clear enough. Of course, it isn’t.

The Income Tax Act in effect expects businesses to earn profits and pay taxes. Not every year, of course, and not in a startup phase. Section 9 (1) of the act incorporates this intent to earn a profit as a test for the deductibility of losses. So investing in something that will be a loser for the foreseeable future does not pass.

But there’s confusion. A landmark Supreme Court case in 2002, wherein an investor claimed huge interest expense on four mortgaged, highly-leveraged condos which created a significant loss, seemed to quash the ‘reasonable expectation of profit’ argument.

Other court rulings have suggested holding property for long-term capital gain is sufficient reason to allow the deduction of short-term losses from income. Meanwhile tax expert Gerry Vittoratos offers this interpretation:

With almost all cases where business/property losses are disputed by the CRA, the reason is based on the concept of reasonable expectation of profit. There must be an intention to make a profit in order for these losses to be deductible. However, in many cases contested by the CRA, the intention is not enough; there must be a solid business case made that the business/property is capable of turning a profit. This is what is commonly referred to as “reasonable expectation of profits” test.

So these days a number of things have changed, promoting more CRA scrutiny. Interest rates may elevated, in the 5% range, but they’re not excessive – which was a key point in the 2002 ruling (when rates were 8-9%). Plus now, with the condo market in reverse, there is no capital appreciation taking place. The opposite. Depreciation.

The point of the tax dudes is that those who bought precon units at the apex of real estate FOMO madness to rent out now at a 100% guaranteed loss with no realistic expectation of either profit or capital gain should paddle in their own bathtub. Quacking. (By the way, this week came news rents are falling year/year. More red ink.)

Of course, if your losses are disputed and disallowed, you can always file a notice of objection and ultimately go to tax court. Good luck with that.

Or you can sell the sucker. In this market that will mean adjusting the price until there is a buyer and, probably, a meaningful capital loss. The CRA will not let you deduct this from capital gains, particularly if the unit sells within a year after closing. The anti-flip law clearly prevents that.

Finally, if you still harbour any illusions about being a landlord or buying a property with rent-paying tenants, meet Ayesha. She’s now living in her car. Here’s why.

Yeah. Next time buy an ETF.

About the picture: “I enjoy the blog,” writes Jim, “but when I read them to Lucy it makes her sleepy.”

To be in touch or send a picture of your beast, email to ‘garth@garth.ca’.