Francesco and Maria are getting old. They live on a 20 acre property they purchased back in 1980 for $100,000. The property is currently valued at $1,000,000. While they are both still fit and healthy, they realise that the property is starting to get too much for them to look after. However, they dont want to move into another home. Ideally, they would like to sell some of the land and retain a smaller block of land with their current house on it and continue to live there.

Their eldest son, John, a lawyer, and experienced property developer, makes some enquiries and discovers the local Council recently changed the zoning of the land to allow subdivision of the land into one-acre blocks. He proposes the following solution to Francesco and Maria:

1. The land should be subdivided into 20 one acre blocks.
2. Francesco and Maria should appoint John as project manager to take responsibility for all aspects of the subdivision project. Francesco and Maria will not be actively involved in any of the subdivision activity.
3. Houses will be built on each of the vacant blocks of land. Once the houses are built, the 19 blocks with the new houses on them will be sold for $300,000 each. The combined costs of developing eachhouse and land package are estimated at $150,000.
4. One block will be retained - the one with Francesco and Marias existing house on it. Francesco and Maria will continue to live in that house on that block of land.

Council has advised that to give their consent to the project, they would require the blocks to be fully fenced and for a sealed road to be constructed for accessing the blocks. However, John proposes that they also install footpaths, guttering, and street-lighting to make the blocks more appealing to prospective buyers.

Francesco and Maria are nervous about the plan and come to you for advice. They ask you two questions:

1. What are the income tax consequences of the proposed arrangement for Francesco and Maria? Based on the information provided, include some calculations of what you estimate to be their taxable income (if any) from the proposed arrangements.
2. Is there another way they could achieve the same result (subdivision with Francesco and Maria continuing to live on a smaller block with their house on it) which could generate lower taxable income?

Point out any assumptions you have made or any further information you would like from Francesco and Maria to support your advice or calculations.