Question

Mr. RH purchased 30 acres of undeveloped ranch land 10 years ago for $935,000. He is considering subdividing the land into one-third-acre lots and improving the land by adding streets, sidewalks, and utilities. He plans to advertise the 90 lots for sale in a local real estate magazine. Mr. RH projects that the improvements will cost $275,000 and that he can sell the lots for $20,000 each. He is also considering an offer from a local corporation to purchase the 30 acre tract in its undeveloped state for $1.35 million. Assuming that Mr. RH makes no other property dispositions during the year and has a 35 percent tax rate on ordinary income and a 15 percent tax rate on capital gains, which alternative maximize his cash flow and why?

Answer 1

Answer -

Compute the after-tax cash flow if Mr. RH develops the land.

Particulars	Amount
Sales proceeds (90 x $20,000)	$1,800,000
Basis($935,000 + $275,000)	($1,210,000)
Ordinary gain on sale of inventory	$590,000
Tax rate	0.35
Tax	$206,500
Cash proceeds	$1,800,000
Cost of inprovement	($275,000)
Tax cost	($206,500)
After tax cash flow	$1,318,500

Mr. RH after tax cash flow if devlops the land $1,318,500

Compute the after-tax cash flow if Mr. RH sells the land.

Particulars	Amount
Sale proceeds	$1,350,000
Basis	($935,000)
Capital gain on sale of investment	$415,000
Tax rate	0.15
Tax	$62,250
Cast proceeds	$1,350,000
Tax cost	($62,250)
After tax cash flow	$1,287,750

  Mr. RH after tax cash flow if sale the land. $1,287,750.

Conclusion :-Mr. RH develops the land alternative maximize his cash flow as the after tax cash flow is higher than the selling of land