Date: 19980604
Dockets: 97-1455-IT-I; 97-1456-IT-I
BETWEEN:
DONALD GORDON, ROSEWOOD MEMORIAL GARDENS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Reasons for Judgment
Sarchuk, J.T.C.C.
[1] These are appeals by Donald Gordon (Gordon) from an
assessment of tax for his 1992 taxation year and by Rosewood
Memorial Gardens Ltd. (Rosewood) from an assessment of tax for
its 1994 taxation year. The factual issue which gave rise to both
assessments is the same and in result, the appeals were heard on
common evidence.
[2] In computing his income for the 1992 taxation year, Gordon
reported a capital gain in the amount of $59,296.62 from the sale
to Rosewood of properties at 246 and 252 - 11th Street, Brandon,
Manitoba (246 and 252) and claimed a capital gains exemption of
$33,354. In his assessment, the Minister of National Revenue
(Minister) revised the capital gain from the disposition of the
properties to $14,296.62, disallowed the capital gains exemption
claimed and added $45,000 to Gordon’s income as a benefit
conferred on him in his capacity as shareholder of Rosewood.
[3] In computing its income for the 1994 taxation year,
Rosewood claimed a terminal loss in Class I assets of $15,222 and
a capital loss of $35,267. The assets involved were the
properties in issue. In reassessing Rosewood, the Minister
reduced both the terminal loss claimed to $620 and the capital
loss claimed to $1,517.
[4] At all relevant times, Gordon was the president and sole
shareholder of Rosewood and of Rosewood Funeral Chapel (the
Chapel), the latter being located on 236 - 11th Street, Brandon.
In November 1990, he purchased a property (242 - 11th) adjacent
to the Chapel as part of an expansion plan. The vendor was London
Life Insurance Co. Ltd. (London Life) which was the mortgagee and
had foreclosed on the property.
[5] In June 1991, Gordon purchased 246 and 252 for $10,000 and
$20,000, respectively.[1] London Life again was the vendor having foreclosed on
these properties as well. They were adjacent to one another and
each consisted of an older single family residence which had been
converted into suites and bachelor apartments.
[6] On June 1, 1992, Gordon transferred 246 and 252 to
Rosewood for a stated value of $35,000 and $55,000, respectively.
In 1993, Rosewood determined that it had no further interest in
the properties and both were sold on September 21, 1993 at a
price of $15,000 for 246 and $30,000 for 252.
[7] In addition to the foregoing facts which are not in
dispute, evidence was adduced from Gordon and from J.P. (Pat)
Weir, C.R.A. (Weir) on behalf of the Appellants.
[8] Gordon testified he knew that 246 and 252 were foreclosed
properties and that London Life was most interested in disposing
of them. They had also been on the market in 1990 when 242 was
purchased, but the Appellant declined to make an offer at that
time. Nonetheless, the listing agent[2] encouraged Gordon to make an offer
which he did. He described it as a low-ball offer and says he was
surprised when London Life accepted it.
[9] Gordon testified that the properties were located in the
same block as the Provincial Courthouse and that in the spring of
1992, he received “feelers” from the government
expressing some interest in them for possible expansion.
Cognizant of the fact that a purchase of these properties would
trigger a capital gain, Gordon, on the advice of his accountant,
transferred them to Rosewood. His rationale for the $90,000
transfer price was the interest expressed by a possible purchaser
and a 1990 report prepared for London Life which he said valued
the properties at $105,000. Gordon also relied on municipal
assessments which he says in total amounted to $85,000.
[10] Subsequently, the province purchased a single property
immediately adjacent to the Courthouse and appeared to have no
interest in further expansion. According to Gordon, this coupled
with the sale of the Chapel, diminished Rosewood’s interest
in 246 and 252 and they were listed for sale in August 1993.[3] Gordon wanted to
sell the properties as quickly as possible and so advised the
agent. Listing prices of $35,000 for 252 and $22,000 for 246 were
set and both properties were sold on September 21, 1993 to the
same purchaser for a total price of $45,000.[4]
[11] Mr. Weir[5]
testified that at the effective date of his appraisal, June 1,
1992, the properties were typical of a number of the older
converted residences being rented in the area. The area is mixed,
ranging from single to multi-family residential use, commercial
and public use. In Weir’s opinion, the income approach best
reflected the utility of the properties as a whole under their
present development. He did consider comparable sales but
expressed the view that the age and overall condition of the
subject properties “results in the value by the direct
comparison approach being at the low end of the range of
value”. Weir also made reference to the third generally
accepted appraisal method, being the cost approach but it was, in
his opinion, of little value in this instance. Weir based the
main value of the properties, as improved, on the income approach
to value. He concluded that the market value with respect to 246
- 11th was $36,500 and with respect to 252 - 11th, $33,000.
[12] Mr. Larry R. Bainard, A.A.C.I.[6] testified on behalf of the
Respondent. He testified the subject properties were located in
an area zoned “C-2” (Commercial District) which he
generally described as “developed with older converted
dwellings approaching the end of their useful life”. His
opinion was that the highest and best use of the subject
properties as at June 1, 1992 was “revenue bearing
residential until ripe for redevelopment”.
[13] In performing his appraisal, Bainard also rejected the
cost approach to value as inappropriate in the present
circumstances. Furthermore, although the subject properties were
utilized for investment purposes, he was unable to use the income
approach to valuation because there was no comparable income or
expense information available for analysis. As a result, Bainard
utilized the direct comparison data approach which analysis he
performed both on the basis of vacant land and of land and
building as a whole unit. Bainard utilized six vacant land
comparables to estimate the market value of the properties and
concluded that $5.00 per square foot was appropriate, producing
an estimated value for the two properties in issue of $45,000.
Bainard’s direct comparison approach with respect to
improved property also involved six comparables which as he
conceded, while not close in every respect to the properties in
issue, were in his view a good basis for estimating the subject
properties’ comparative worth. His reconciliation and final
estimate of value of the properties in issue on this basis was
also $45,000.
Issue
[14] The sole issue, which is determinative of both appeals,
is the fair market value of the properties as at June 1,
1992.
Conclusion
[15] It is generally accepted that there are three principal
appraisal methods, namely: the market data or direct sales
comparison approach; the income or economic approach; and the
depreciated reproduction cost approach. The income approach was
selected by Weir as the appropriate method for his appraisal.
This requires, as a general rule, an indirect comparison to be
made between the subject property and other comparable properties
or investment opportunities. The income actually, or
hypothetically, derived from the subject property is to be
compared with the income derived from comparable properties or
other types of investment. Then the income stream from the
subject property is capitalized at a rate derived from an
analysis of the real estate investment market. The resulting
capitalization is deemed to be the capital value of the subject
property. The income approach is based on the economic theory
that the value of property is determined by the amount of the
future earnings which it will yield.[7] Weir’s utilization of this
approach was, in my view, flawed in that no comparison was
performed between 246 and 252 and similar properties or other
types of investment and his conclusion reflects no more than the
use and the income and expense levels of the properties based
solely on data provided by the Appellants.
[16] A further cause for concern is that the basis for the
capitalization rate used by Weir is unsubstantiated by any hard
data. As was correctly observed by Bainard, a prudent informed
investor in properties such as the ones in issue would likely
demand a rate of return on his investment which would in part
depend on the perceived degree of risk involved, the availability
of other forms of investment and other factors. Although Weir is
experienced in his chosen profession his choice of 12% as the
appropriate return on investment appears to be low and as
previously mentioned, is unsupported by data with reference to
similar properties and similar locations. Since the higher the
capitalization rate, the lower the capital value, the manner in
which the capitalization rate is determined is of crucial
importance. Weir assumed that it would be possible to obtain a
mortgage at an interest rate of 10% on the subject properties and
that the lenders would be prepared to lend up to 75% of the
value. On the other hand, Bainard observed that most lenders
would want a premium on properties such as these and given the
risk, might be reluctant to lend money at the rate assumed by
Weir. It must be remembered that the two buildings in issue are
almost 100 years old, are situated in a transitional area of the
City, and are populated by tenants who rent on a month-to-month
basis with no written leases. On balance, there has been a
failure by Weir to support his conclusion by comparing the risk
of the properties in issue with other forms of investment or by
reviewing comparable sales and their respective net revenues.
[17] In his appraisal, Weir estimated the vacancy rate for 246
at 5% and for 252 at 3%. No evidence was adduced as to the actual
vacancy rates during the Appellants’ ownership of the
properties (June 1991 to September 23, 1993), although such
information should have been readily available. Instead, Weir
selected his percentages simply on the assumption that they were
“close to the actual” and “what I felt they
were in 1992”.
[18] One final comment with respect to the Weir appraisal. As
a supplementary approach, he made a direct comparison of five
properties and estimated the value of the subject properties at
$6.00 per square foot or $54,000 in total.[8] In this analysis, Weir ignored the
purchase price of the properties in 1990 and their sale price in
1993. These dispositions were not remote in terms of time and in
each case, were a genuine sale between parties who were acting at
arm’s length. To have ignored them completely was
unquestionably wrong and, indeed, this fact was conceded by Weir
in cross-examination.
[19] Finally, with respect to the Appellants’ reliance
on municipal assessments, I can only say that although
assessments are generally supposed to represent market value, in
practice, this rarely appears to be the case. Even assuming a
high degree of motivation (which in my view, has not been
established with respect to Rosewood’s 1993 sale of 246 and
252), the amounts paid for those properties in 1991 and 1993, (as
well as the listing prices set by the Appellant and its broker)
clearly demonstrate the problems associated with attributing
weight to assessment values.
[20] With respect to the Bainard appraisal, some valid
questions can be raised regarding certain of his residential
comparables and to the fact that no effort was made to determine
whether the vendors in those instances were “willing
sellers”. This issue was raised specifically with reference
to comparable number five where it was said the vendor was
required to sell by virtue of mortgage sale proceedings, and with
respect to comparable number six which was a sale by a mortgage
corporation which had foreclosed on the property. While one might
readily assume that the vendor of comparable number five was
under compulsion to sell, that fact by itself does not
necessarily establish that the sale price was substantially below
fair market value. With respect to comparable number six, absent
any direct evidence, it is speculative to assume that the
mortgage corporation was anything but a willing seller prepared
to sell provided a fair price is obtained.
[21] It was argued on behalf of the Appellants that Bainard
was far too influenced by the selling price of the subject
properties and failed to adequately consider other properties
such as those referred to by Weir. It is a fact that Bainard gave
substantial consideration to the price paid for the properties in
1993 (as well as the listing prices) and concluded that the sale
prices most closely approximated the value of the properties as
at June 1, 1992. As a general rule, sale prices of subject
properties afford an excellent basis for arriving at fair market
value and in the absence of evidence indicating a general
increase in market values, must be considered by an appraiser.
Two further points must be made in this context. First, the sale
in 1993 did not involve a vendor who was required to sell by
virtue of compulsory sale proceedings. Second, by placing the
properties in issue in multiple listing, Rosewood clearly
intended to include every possible purchaser since they were
being offered under conditions which enabled every person
desirous of making a purchase to come in and make an offer.
Rosewood was willing to sell, discussed the issue with its agent,
listed the properties for sale, was offered a price and accepted
it. It may have had no further use for the property but the
evidence of Gordon does not convince me that it was prepared to
sell at any price and on any terms.
[22] In the course of cross-examination, counsel for the
Appellants suggested to Bainard that his appraisal of value
reflected concern for his employment, the inference being that
his opinion would therefore be biased. In my view, there is no
basis for such a suggestion and there was nothing in the
witness’s attitude or in his responses to permit such a
conclusion. While his appraisal does not escape criticism,
nothing therein or in his testimony supports the suggestion of
bias.
[23] I have already indicated that I am unable to accept the
valuation of Weir based as it was primarily on the income
approach. With respect to the Bainard appraisal, I must observe
that the use of the comparison approach may on occasion be
misleading since there is often difficulty in identifying
properties that are comparable in fact and in assessing the
degree of comparability. In the present case, the problem appears
to be compounded by virtue of the fact that there did not appear
to be much of an active market with respect to such properties.
Where little sound comparative data is available, an estimate of
market value is very dependent upon the experience and common
sense of the appraiser. While I have some reservations regarding
Bainard’s appraisal and his testimony, I do not believe
that his conclusions are so flawed that this would be an
appropriate instance where I might properly form my own opinion
of valuation.
[24] Since the Appellants have failed to demonstrate on a
balance of probabilities that the Minister’s assessments
were incorrect, the appeals are dismissed.
Signed at Ottawa, Canada, this 4th day of June, 1998.
"A.A. Sarchuk"
J.T.C.C.
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