Question

Mr. Jones purchased 20 acres of undeveloped land on the outskirts of Denver 12 years ago for $1,500,000. He has held the land for investment ever since. Mr. Jones is now considering two options for selling the land, as follows:

First, Mr. Jones is considering subdividing the land into 0.25 acre residential lots and improving the land by adding sidewalks, streets, and utilities. Mr. Jones estimates that these improvements will cost $1,900,000. After improving the land, Mr. Jones plans to advertise the lots for sale at a cost of $175,000 each.

Second, a real estate development company has offered Mr. Jones $9,350,000 cash to purchase the land in its current unimproved condition.

Assuming Mr. Jones faces an ordinary tax rate of 35% and a long-term capital gains tax rate of 15%, which alternative (i.e., develop the land or sell it “as is”) maximizes Mr. Jones’s post-tax cash flows? In addition to any calculations, your answer should include a short statement explaining your conclusion.

Answer 1

Option 1 Considers the Asset being subdivided to .25 acres residential plot, after improving provides higher cash flow.