Cottage intentions count with taxman
For those fortunate enough to own a vacation property, Thanksgiving weekend is often the last time the family will gather together at the cottage or cabin until next year’s May long weekend.
While the benefits of sipping a gin and tonic on a summer day on the dock or cruising around the lake may justify the cost of that second property, the ability to defer some of the expenses by renting it out when you’re not there can often make or break the decision to purchase that second home.
But renting out your vacation property is not always as easy at it seems and can lead to trouble with the taxman if you try to claim rental losses when the revenue doesn’t materialize.
Take the recent case of Mike Daoust, who in 2004 purchased a cottage at Moth Lake in Manitoba. In 2005 and 2006, he claimed rental losses of more than $9,000 and $6,500 respectively. He sold the cottage last year for an $80,000 gain.
At trial, Mr. Daoust testified that he purchased the property both to generate income and as a capital investment. “The cottage was attractive due to its very private location and proximity to Winnipeg. The cottage was winterized and could be rented year round,” he said.
Mr. Daoust felt he could rent it out to family, friends and colleagues for $1,600 a week, despite evidence that rental rates for comparable properties were substantially less.
He spent two months in 2004 preparing the cottage for rental, and it was available beginning in 2005. In addition to offering the property to family, friends and colleagues, he claimed he also attempted to rent it to strangers by advertising the property in a Winnipeg daily newspaper, the Kenora local paper and an online rental website. He said he also placed posters in various places close to the cottage.
Yet, Mr. Daoust was unsuccessful in renting the cottage in 2005, rented it for only two weeks in 2006 (one week to a friend and a second week to his brother) and one week in 2007 to a third party. His total rental revenue over the three years was only $4,400.
In order to deduct rental or business losses, the Supreme Court of Canada ruled in 2002 that if there is some personal element to the activity in question, you have to apply the “pursuit of profit source test.”
In other words, was Mr. Daoust’s predominant intention for purchasing the cottage to make a profit? And if so, was the rental of the cottage “carried on in accordance with objective standards of business-like behaviour?”
The judge in his case held it was not. Citing there was no business plan and that the weekly rental rate was “unrealistic,” the he denied the losses, concluding that Mr. Daoust’s primary intention was to use the cottage for personal purposes, “with occasional rentals to reduce the cost of maintaining the property.”