Pappas Estate v. The Queen, 81 DTC 5178, [1981] CTC 266 (FCTD)

J Walsh, J:—Plaintiff, pleading his own case contests the income tax assessment of his father the late George Pappas for the 1976 tax year during which the said George Pappas died on November 9, 1976, as a result of which plaintiff inherited from him the building situated at 862-864 Kingston Road, Toronto. Pursuant to paragraph 70(5)(a) of the Income Tax Act the said George Pappas was deemed to have disposed of the said property immediately before his death and to have received the proceeds of disposition equal to the fair market value of it at that time. The late George Pappas had acquired the property on May 1, 1972, for $34,000 and the Minister evaluated the property as of his date of death at $65,000 resulting in a capital gain of $31,000 which was taxable to the extent of $15,500.

Plaintiff’s two principal arguments are invalid. In the first place he claims that it is unjust to tax a gain on a property that has not been sold and furthermore that, had he been able to move into the upper part of the property and live there, as he did, not long after his father’s death and had then subsequently resold the property at a time of his choosing there would have been no taxable capital gain on the portion of the property used as his residence. He contends that to deem that there was a sale when in fact there was none and when he had not yet had an opportunity to move into the residence (where his late father had not resided) creates an unjust situation. While one can understand the validity of these arguments from his point of view, unfortunately the law states that there is a deemed disposition at the date of death and this has to be applied.

Plaintiff’s second argument is to the effect that the assessment did not take into account any factor of inflation. While it is true that property values have gone up rapidly as the result of inflation, unfortunately this is not taken into account in the calculation of capital gain. In any event in the present case an expert witness, M S McGee who was called by defendant testified that there was little if any escalation in prices of property of this sort between 1974 and 1976 as these properties are not purchased as investments. Similar properties on the same street have a ground floor with possibly a new front added which is rented as a store with a residence above, as in the case of the subject property and the market for them is to purchasers who wish to live in the upstairs premises and occupy for themselves, or rent the commercial premises on the ground floor to obtain revenue to carry the property, and this market did not change greatly in the period in question. This argument is therefore also unacceptable.

Plaintiff is entitled however to dispute the figure of $65,000 at which the property was evaluated as of November 9, 1976, on which the capital gains tax was based. He suggests in the statement of claim that the real gain should be considered as $12,000 so as to permit an equitable adjustment for the inflation factor, which adjustment as indicated cannot be allowed for. He called no expert evidence himself and was therefore forced to rely on his cross-examination of defendant’s expert whose report was produced and who testified. The said expert Mr. McGee is well qualified. In addition to being an accredited member of the Appraisal Institute of Canada and the Real Estate Institute of Canada he has been a senior appraiser for the Department of Highways of Ontario, the Municipality of Metropolitan Toronto, the Crown Trust Company, and Revenue Canada, and has also been in the real estate brokerage business. He is familiar with the Metropolitan Toronto area and has carried out appraisals for many government departments, leading corporations and law firms. He adopts two approaches to his evaluation, the market value approach and the income approach although he quite properly attributes more weight to the former approach, since the income approach always involves the use of a number of intangibles in which personal judgment is an important factor. He was unable to make any detailed inspection of the inside of the subject property, which is perhaps unfortunate for plaintiff, since according to plaintiff’s evidence it is not in a very good state of repair which might have made it less valuable than some of the comparables. It was built in 1908 but subsequently a front addition was added and the ground floor has been utilized for some years as a retail outlet. A non-basement rear addition was subsequently added for storage purposes with an outside entrance from the lane at the rear and a connection with the front store from inside. The upper floor contains a living room, two bedrooms, a kitchen and bath, and according to plaintiff’s evidence an uninsulated sunroom at the rear of the upstairs premise. The building proper with front store addition contains 2,124 square feet, the rear shed addition 1,075 square feet. The highest and best use according to Mr McGee is the use presently being made of the premises. The witness located five comparable sales all in the 900 block on Kingston Road between September 1, 1974 and February 5, 1978, prices ranging from $22.97 to $28 per square foot of floor area, the latter sale in 1978 indicating to the witness an escalation in prices at that time. All are similar properties minus the rear addition to subject property. The witness took the lower figure and applied $22 per square foot to 2,124 square feet arriving at a value of $46,728 for subject property. He then added $10 per square foot for the addition on the rear for another $10,750 making a total of $57,478. If the report had stopped there then his final conclusion of giving an evaluation of $57,000 to subject property on the date in question (which is $8,000 less than the figure of $65,000 on which the tax assessment was made) would appear to be reasonable. He also chose to use the income approach however, although he stated that this was primarily to check the accuracy of his other figures. He concluded at evaluation at $4 per square foot for rental of the retail store of 1,175 square feet or $4,700 plus $300 a month rental for the upstairs apartment or $3,600 per annum, $1.50 per square or $1,612 for the rear addition making total estimated rental of $9,912. He then estimated operating expenses at 35% of this or $3,469 leaving a net income of $6,443 which he then capitalized at 12% to arrive at a figure of $53,692. He had less confidence in this figure however than in the figure of $57,478 reached by the comparative approach since he does not attempt to take an average but concludes for an evaluation of $57,000.

It was the income approach which plaintiff attacked in a skilful cross- examination. In the first place the witness admitted that he had made no allowance for vacancies of premises and that if he had done so this might have reduced his potential rental figures by 5%. This adjustment alone would have reduced the net estimated rental figure after allowing for operating expenses by some $322 and the capitalized evaluation by some $2,683 resulting in a figure on the income approach of $51,009 as against $53,692.

Furthermore he admitted that in his income figures he made no provision for capital cost allowance and he conceded that his estimated operating expenses of 35% might be somewhat low for property of this nature, covering only taxes and insurance. On the other hand his capitalization rate of 12% may be somewhat high at that time. He conceded that he had not obtained information from the owners of any of his comparables as to the actual rentals obtained for the stores, nor the residential premises above, most of which information could not be obtained in any event since the premises were frequently owner occupied. He therefore had to use his judgment and experience as to what he considered would be appropriate r entai for the st ore premises, apartment above, and shed at the rear, which in the present case was used by Pappas himself. He stated that in the income approach he would not be overly impressed by actual figures in any event because there might be a short lease at a very low rental for one reason or another, but what he is concerned with in this approach is what would be a normal rental which an investor might anticipate to receive for the premises.

However Mr Pappas was able to establish from the late George Pappas’ 1976 income tax return that the actual rentals received in that year were only $2,925, a far cry from the potential of $9,912 used by Mr McGee and actual expenses were 4,080.84 substantially above the $3,469 Mr McGee would allow by taking 35% of the rental potential estimated by him. This portion of Mr Pappas’ return had been assessed without protest. Mr Pappas testified that this $2,925 rental was made up of $1,350 for the apartment and $1,575 for the store. He conceded however that in 1976 the store had been vacant for a portion of the year. He testified that if it had been fully occupied the rental would have been $3,000. Full occupancy of both premises together with the allowance of $1,612 established by Mr McGee for the rear area occupied by him would have yielded an income of $5,962 according to him. If this figure were taken, which represents actual figures and not potential, and Mr McGee’s 35% estimate for operating expenses amounting to $2,087 were deducted the net would be $3,875, and if this were capitalized at Mr McGee’s figure of 12% the evaluation from an income approach would be $32,300.

While Mr Pappas does not seek such a low evaluation this evidence certainly casts serious doubt on evaluation by the income approach. In his notice of objection plaintiff had suggested an evaluation of $53,000, although he reached this figure by making an allowance for inflation from the time of purchase in 1972 to the date of deemed sale, which I have found to be an unacceptable approach.

Mr McGee is a very competent experienced appraiser and gave his evidence very frankly and impartially. Plaintiff also conducted his case in a very moderate and intelligent manner, setting forth cogent arguments meriting consideration.

Had Mr McGee ignored the income approach altogether and confined himself entirely to the comparative market value approach his figure of $57,000 would have been acceptable, especially as he was able to find a number of similar comparables. However he did also, and I am not criticizing him for doing so, attempt an income approach, although admitting it to be less accurate and in fact he largely set it aside since his comparative approach showed a value of $57,478 and his income approach based on theoretical rental figures a value of $53,692. Accepting the fact that he himself admitted that he should have made an allowance of 5% for vacancy, which in the case of subject property certainly was insufficient, his income approach would have resulted in a figure of $51,009, as I have stated. Actually there is no hard evidence that any of the comparables did yield the net income which he suggests an investor might consider as being normal. Looked at in this light, and considering the considerably lower income which the late George Pappas was in fact getting from the property, although the vacancies of the 1976 year might not be normal, it would appear that Mr Pappas’ suggested figure of $53,000 in his notice of objection, although calculated on the wrong basis is by no means out of line. In fact if we take a mean between a $57,478 figure obtained by the comparative approach and the $51,009 obtained by the corrected income approach, the mean would be approximately $54,000, and, giving slightly more weight to the comparative approach, a figure of $55,000 might not be unreasonable.

Of necessity Plaintiff is going to succeed in this action in any event since at the very worst the assessment will be reduced from $65,000 to $57,000 as a result of the report of defendant’s own expert.

Taking the evidence as a whole I conclude that an evaluation of $55,000 would be an appropriate figure so that the capital gain would therefore be one half of the difference between this figure and the purchase price assessed at $34,000, or one half of $21,000 making a taxable capital gain of $10,500. The assessment will be returned to the Minister for reassessment in accordance with these reasons. Plaintiff, not being an attorney is not entitled to court costs pursuant to Tariff B but is entitled to recover from defendant all disbursements made pursuant to Tariff A.