Question

Nikki owns and carries on a chain of clothing stores. So far she has 7 of such stores. When she chooses a premises to open a new store on, the most important criterion is where she can maximise the sales of clothes. However, she is also influenced by the potential for the land on which each of the shop premises is located on to grow in capital value.

In late 2019, Nikki decides to develop one of the shop premises, because real estate in the area which it is located on had appreciated markedly in recent years. This involved Nikki obtaining a building approval from the local council, demolishing the shop, and building a 6 storey apartment building on the land. As Nikki did not know much about building, this consisted of contracting a major builder to be in charge of the process of building the apartment. These apartments are sold individually to the public through a leading real estate agent.

Ignoring Capital Gains Tax, discuss whether the sales proceeds from the apartments generate ordinary income.

Answer 1

Nikki's proceeds from the sale of the apartments generated ordinary income. It is because Ordinary income is derived from short-term operations that can be paid to the earner in the form of salary, sales revenue, commission, bonus, interest on investment, wages, rental income, or royalties.

When capital gain is earned from investments, it has to be determined whether the source is a short-term investment or a long-term investment. When the income or capital gain is from a short-term investment, it is considered ordinary income and is taxed at a higher rate .

Nikki had not held the apartments for a long period hence it will be considered to have made a sale of apartments from short-term investments. If he could have held the apartments for longer period, they would have qualified for long-term capital gains nd is taxed at a lower rate.

Therefore, the income earned from the sale proceeds of the apartments is ordinary income to Nikki.