Herbert Krahn v. Minister of National Revenue, [1974] CTC 2142, 74 DTC 1117

The Assistant Chairman:—This is the appeal of Herbert Krahn from income tax assessments in respect of the 1968, 1969 and 1970 taxation years.

There are two distinct issues to be determined in this appeal. First, whether the allocation between land, building and fixtures made by the Minister of National Revenue pursuant to paragraph 20(6)(g) of the Income Tax Act in assessing the appellant on the disposition in 1968 of a property situated at 632 7th Avenue North in Saskatoon was reasonable.

Secondly, whether the profit realized by the appellant in the acquisition of properties known as 220, 222 and 224 10th Street East, Saskatoon and the property known as 1430 Alexandra Avenue in Saskatoon and their subsequent disposition constituted a capital gain, or whether it was taxable income from a business within the meaning of sections 3, 4 and paragraph 139(1 )(e) of the Act.

The evidence in this appeal indicates that the appellant was born on a farm some 30 miles from Saskatoon and that he moved to Saskatoon after his father’s illness. He then worked for the University of Saskatchewan in Saskatoon and for Hudson’s Bay Company. The appellant was employed 6 /2 years with the T Eaton Company (hereinafter referred to as “Eaton’s”). He married a Saskatoon girl in 1951. He was thereafter employed some 15 /2 years in the Contract Sales Division of Simpson Co Ltd (hereinafter referred to as “Simpson’s”) and was concerned principally with the furnishing and layout of hotels, motels and hospitals. In 1967 he was made manager of that Division and worked in that capacity until June 1970.

The appellant’s home, his ties and roots, therefore, were in and about Saskatoon. From about 1964 some difficulties were realized by department stores. Eaton’s laid off a great many people. In 1967, at a meeting of branch managers of Simpson’s, the eventual closing of the Contract Sales Division was announced. After several important changes made in the management of Simpson’s, the appellant in January 1970 was offered a transfer to a Toronto branch of Simpson’s as a salesman. The appellant refused to leave Saskatoon and was subsequently released in June 1970. He attempted in vain to get employment in Saskatoon. He went to Vancouver for a time but finally settled in Calgary where he now owns his own home but has no other properties.

Dealing with the first issue, ie the purchase and sale of the property at 632 7th Avenue North, the appellant purchased the property, a light housekeeping block (a rooming house) in 1963 which consisted of a basement, main floor, second floor and attic classified as 2 /2 storeys which property was all rented. The appellant’s rental revenue from the property was between $305 and $315 a month. There is evidence to the effect that considerable repairs were effected on the property during that period of time—new plumbing, wiring, painting and flooring. The appellant had consistently sustained a loss on the property except for the last year when a profit of $300 was realized. On July 25, 1968 the property was sold under an offer to purchase to Marie Streeter (Exhibit A-1). The selling price was $22,000 and it is contended that the property was sold at a loss. Because the house was 50 years old and allegedly in fairly poor condition, the appellant fixed the value of the building at $6,604.32, the land at $12,000, and furniture and fixtures at $2,056.68.

In a first allocation between the depreciable and non-depreciable assets in question, the Department of National Revenue fixed the value of the land at $3,980, the building at $14,600 and furniture and fixtures at $2,100. However, because of, and on the basis of, an evaluation report carried out by J M Warren, AACI (Exhibit R-2), the respondent at the hearing adjusted the land valuation to $6,110, the building to $12,470 and furniture and fixtures to $2,100. It is the difference be- tween these adjusted figures of the Department of National Revenue and those of the appellant which is now in issue. The. Board must therefore decide which of the two evaluations made of the land in question is the more realistic. The appellant’s evaluation of the land was supported in part by Mr Murdock who is not an accredited appraiser. However, he owns his own real estate firm and has been in real estate business in Saskatoon since 1957, engaged in all types of real estate transactions. Mr Murdock, who did not know the exact dimensions of the land in question but who had been involved in both the purchase and sale of the property, estimated from his general experience that the value of land in the area, based on a 50 foot frontage and full depth lot of 125 to 130 feet, would be between $15,000 and $18,000 but that a 50 foot frontage lot which is not full depth could be evaluated at $9,000 and he considered that the lot at 362 7th Avenue North could be evaluated at $9,000—$3,000 less than the appellant’s evaluation of the land.

The appraisal on which the respondent relies (Exhibit R-2) was made by Mr Warren, an accredited appraiser, a member of the Appraisal Institute of Canada and of the American Institute of Real Estate Appraisers. In his report Mr Warren describes the land in issue in this appeal as a partial lot, measuring 46.83 feet frontage on 7th Avenue and 75 feet on King Street—a total land area of 3,512 square feet. These figures were not contested by the appellant. Based on comparable sales of properties and verified through the land titles office, the report indicates that land used for redevelopment is just over $2 a square foot but that the land in connection with properties purchased as rental houses has a value of $1 to $1.50 a square foot. The subject property is considered in the report as being too small for redevelopment and the basis of $1 to $1.50 a square foot is applicable. The report concludes that the fair market value of the land is $6,500 which, with the necessary adjustment, comes to $6,110 which is the figure used by the respondent in allocating the value of the land at 362 7th Avenue North.

There is a difference of $2,500 in the evaluation made by Mr Murdock and Mr Warren of the land. However, it would appear that Mr Murdock’s evaluation of the land at $9,000 is on the assumption that it has a full 50 foot frontage. Since the value of land is largely dependent on the use that can be made of it, and since by-laws 5(a) and 6(a) for R4 district in Saskatoon (Exhibit R-4) in which the subject property is located require a minimum of 50 foot frontage and 6,000 square feet of area for multiple unit dwellings and boarding houses, and since the subject property does not meet these minimum requirements, the use that the land can be legally put to is considerably reduced and its value is consequently less.

In my opinion, Mr Warren’s evaluation of the land is more realistic and more in keeping with the use to which it could be put. From the photograph included in the appraisal report (Exhibit R-2) and that in (Exhibit R-3) it would seem that the building is quite substantial and it does not appear to me to be realistic to evaluate the house, for which considerable repairs are claimed by the appellant to have been made, at only $6,600 when the purchase price of the house some five years earlier was estimated at $16,496.64. I am of the opinion, therefore, that the allocation of $6,110 for the land and $12,470 for the house is a reasonable allocation of the depreciable and non-depre- ciable assets in the disposition of the appellant’s property at 362 7th Avenue North, and it is this allocation which should be used in assessing the appellant for the 1968 taxation year, and not the allocation made in the reply to the notice of appeal.

In dealing with the second issue as to whether the profits realized on the sale of properties situated at 220, 222 and 224 10th Street East, Saskatoon and the property situated at 1430 Alexandra Avenue in Saskatoon were a capital gain or income, it is important that all the facts relative to each property be taken into account.

In July 1967 the appellant purchased the property known as 224 10th Street East, Saskatoon, and some four months later purchased the adjoining properties, 220 - 222 10th Street East, for a total price of $24,935 allegedly for the purpose of building an apartment designed for retired people. The property consisted of two buildings and one vacant lot. Plans were allegedly drawn up and the construction was to be undertaken by Midland Industries. The estimated cost price of the building with swimming pool and parking area would have been in the vicinity of $200,000. The appellant claims that his intention was to sell his two other properties in order to help finance the construction of the apartment building. Not having consulted any lending institution before the purchase of the said property, the appellant found that Canada Permanent Trust, the Royal Trust and Huron Erie Trust Companies’ conditions of financing the project were prohibitive, as were indeed Crédit Foncier Franco-Canadien’s condition on a second mortgage which would have been required because 97.5% financing was. being sought. The property was rented in the meantime and no further action was taken to realize the apartment building project because, according to the appellant, the rental market had softened since the purchase of the property.

Marion Minshull Enterprises Ltd, which owned and operated several apartment buildings and which owned land immediately adjacent to 220, 222 and 224 10th Street East, approached the appellant and offered to purchase the said three lots for the purpose of building a 60-suite apartment building. The sale was completed on May 15, 1969. The selling price was $40,000 and the appellant considered that the profit on the sale was a capital gain.

Evidence indicates that the appellant, because of several transactions he had concluded, had some knowledge of real estate values. It is somewhat difficult to conceive that the appellant, before the purchase of the 10th Street East property on which he proposed to build an apartment, did not also know the high cost of financing which was generally known to exist at that time. Moreover, the reason given by the appellant for not proceeding with the construction of the apartment building was the softening of the market. According to evidence adduced, the overall building permits granted. by the city of Saskatoon were for a value of $57,169,128 for 1967; $52,737,762 for 1968; $43,759,100 for 1969; $13,425,200 for 1970; $22,662,600 for 1971 and $24,638,900 for 1972. According to CMHC reports, the vacancy rates of rental dwellings were 10.1% in 1969, 20.3% in 1970 and 16.4% in 1971.

Counsel for the appellant pointed out that these figures were not broken down into the different types of construction and held, without however providing any evidence, that the figures included government projects such as schools etc. Even if that were so, it seems to me that the softening of the construction market and the drop in rental market were subsequent to the appellant’s sale of the property and the appellant, having sold the property in the beginning of 1969, cannot logically claim that the reason for selling it was the deterioration of the market which had not yet occurred. It must also be noted that the appellant sold the property to a company whose purpose was to build a 60-suite apartment. From this we can legitimately infer that the softening of the rental market had not yet occurred when the purchase was made.

On the balance of probabilities, it appears to me that the appellant, in purchasing the land before any plans were made for the construction of an apartment, and before any consideration was given to the possibility of his financing such a project, did not take the necessary preliminary steps and did not act as a person whose purpose and intention it was to build and operate an apartment building. It rather appears that the appellant had the opportunity to buy an interesting parcel of land made up of three lots at a time when construction was flourishing in Saskatoon and when he could easily sell at a profit which he, in fact, did.

On the basis of the facts before me, I conclude that the profit made on the sale of the property at 220, 222 and 224 10th Street East, Saskatoon was a result of an adventure in the nature of trade and therefore taxable income.

The appellant who was a resident of, and was earning his living in, Saskatoon had over the years purchased, sold and traded properties, some at losses which were considered as being on capital account, but with which we are not directly concerned in this appeal. However, in 1969 he owned a property at 1429 Alexandra Avenue in Saskatoon which was operated on a lease basis. Mr Murdock, a real estate agent whom the appellant knew well, advised him that a company known as Honeyboy Bread Stores which consisted of a chain of confectionery stores, was seeking to buy 1430 Alexandra Avenue to open a Honeyboy confectionery store on the premises. The appellant felt that should Honeyboy establish itself at 1430 Alexandra Avenue, the confectionery store at 1429 Alexandra Avenue would be forced out of business and the premises would be vacant. This rumour occurred at a time when he knew that his employment at Simpson’s was insecure. In order to prevent Honeyboy from purchasing 1430 Alexandra Avenue, the appellant in September 1969 purchased 1430 Alexandra Avenue and converted it into a butcher shop for a total cost of $38,000. On September 17, 1969 he entered into a partnership agreement with Nick Satzewich for the operation of a butcher shop at 1430 Alexandra Avenue to operate under the name of North Park Penny-Wise Meats (Exhibit A-2). It is on record that Nick Satzewich, a butcher by trade, would enter into the aforementioned partnership on the condition that he be given the first option to purchase the butcher shop at a price representing 10% above cost.

The partnership, in fact, existed for only two or three months. The appellant, having learned that some $800 had been unjustifiably withdrawn from the business by his partner, decided to allow Nick Satzewich to exercise his option and sold the butcher shop to him. The sale, however, contained a caveat which precluded the purchaser from operating a confectionery store on the purchased premises.

From the facts surrounding the purchase and sale of 1430 Alexandra Avenue, I am satisfied that the appellant’s only intention in acquiring che property was to protect his income from the rental of the confectionery store at 1429 Alexandra Avenue at a time when he foresaw the cessation of his income from his employment at Simpson’s. The sale of the property by the appellant is, in my view, ample justification for his not desiring to remain in a partnership with someone in whom his confidence had been shaken. My conclusion, therefore, is that the profit realized by the appellant on the sale of 1430 Alexandra Avenue in Saskatoon is a capital gain.

In summary I hold that in the appellant’s disposition of the property at 362 7th Avenue North an amount of $6,110 should be allocated to the land, an amount of $12,470 allocated to the building and $2,100 to furniture and fixtures. I further hold that the profit realized on the sale of the property at 1430 Alexandra Avenue is a non-taxable capital accretion. The appeal is therefore allowed in part and the matter referred back to the Minister for reconsideration and reassessment.

Appeal allowed in part.