A recent decision of the Tax Court of Canada will be of interest to those who hold rental property for the long term and who incur expenses related to the zoning of that property. The Tax Court found that such expenses were deductible for tax purposes, and were not required to be capitalized to the cost of the property.
The Income Tax Act (“Act”) distinguishes between payments which are on account of income and those which are on account of capital. The distinction is not clear, and there has been considerable commentary and litigation on the subject. Payments on account of income are, very generally, deductible provided that they meet the requirements of the Act. A key requirement is that the payments are incurred for the purpose of earning income from a business or property.
Payments on account of capital, in contrast, are not deductible unless there is an applicable exception in the Act. Paragraph 20(1)(cc) of the Act is relevant to re-zoning expenses. It states that a taxpayer can deduct from business or property income the cost of making representations to a municipal body for the purpose of obtaining a licence or permit relating to the business carried on by the taxpayer. Canada Revenue Agency has, in the past, indicated that this includes a rezoning application. Unfortunately, for certain taxpayers, holding rental property may not involve sufficient activity to constitute a “business”.
The key issue, then, is whether a payment made for re-zoning expenses of a rental property is made on account of income or capital. It was this issue which was before the court in Jennings v. The Queen.
The taxpayers in Jennings were two individuals who bought a residential property in Ottawa in 1987. It had three rental units, including one in the basement. When they bought the property, the taxpayers relied on a report on zoning from the City of Ottawa that indicated that there were no zoning violations.
In 1993, the taxpayers received a notice of violation of zoning by-laws from the City. The City took the view that the property could only have one rental unit. The taxpayers applied for rezoning “to legalize the property as a three unit converted dwelling”. In the application, the taxpayers observed that the property had been assessed property tax since 1980 as a three-unit building.
The City delayed considering the taxpayers’ application for a number of years. In 2010, the taxpayers made a new application with the assistance of a planning consultant, incurring costs to do so. The application was approved.
The taxpayers deducted the costs of making the 2010 application for tax purposes. The Tax Court found that this was the correct approach:
According to the evidence, which I accept, the appellants applied for the zoning amendment in 1993 and again in 2010 as the best way of dealing with the notice of zoning violation and in accordance with professional advice.
In my view, the expenditures should be viewed as ordinary expenditures incurred in connection with the day-to-day management of the rental property. It is true that the expenditures would likely have a long term benefit in the sense that the property was now clearly in compliance with existing by-laws. However, I do not think that this should tip the balance to result in the expenditures being non-deductible capital expenditures.
Defending Zoning Complaints
The Court in Jennings considered the costs incurred in rezoning rental property. Owners may also incur legal costs in defending zoning complaints. In a 2009 decision the Tax Court found that such costs were incurred to allow an owner to continue to earn rental income, rather than to preserve the taxpayer’s interest in a capital asset. Accordingly, they were deductible.
If you own rental property, and incur zoning or rezoning costs, you should consider whether these may be deductible. In general, each year, those who own rental properties should carefully review and categorize costs relating to those properties to ensure the appropriate and most beneficial tax treatment.
Our Real Estate Law Blog provides brief commentary on current legal trends and developments affecting your business. The topics addressed in Lawson Lundell’s Real Estate Law Blog are of interest to commercial real estate developers, real estate and strata agents, investors, landlords and tenants, as well as a variety of industry groups.