Gordon v. R., [1998] 3 CTC 2759

Sarchuk T.C.J.:

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.

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.

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.

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 - llth) 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.

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.

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.

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.

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.

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.

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]

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.

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”.

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

The sole issue, which is determinative of both appeals, is the fair market value of the properties as at June 1, 1992.

Conclusion

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.

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 un- supported 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.

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”.

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.

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.

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.

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.

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.

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.

Since the Appellants have failed to demonstrate on a balance of probabilities that the Minister’s assessments were incorrect, the appeals are dismissed.

Appeals dismissed.