Return on Equity Calculation. Can anyone please explain?


Just an example,

Say an investor invests $1M in purchasing a land. To purchase the land, the investor had to pay a tax of $50K. So, his total investment becomes $1.05M. Now, he tells his friend who is a real estate agent to construct a building and sell the building. His friend accepts to help and agrees to construct and sell it for him and give him the profits back. The friend does the same and returns the profit of $500K to the investor.

So, now to calculate ROE, should the investor remove his initial tax paid of $50K from the returns and calculate his actual return on $450K / $1M or $450K / $1.05M

I’d say that it should be $500,000 / $1,050,000.

What makes you believe that you should subtract $50,000 from the profit of $500,000?

The tax is part of the initial investment, so added to your equity outlay, not the returns. After purchase you have made a net loss on paper.

So I agree with the above it would be 500,000/ 1,050,000.

The bit that is probably confusing you is the inital 50,000 tax in some regions can he deducted from capital gains tax on sale to reduce you tax bill and therefore push up your earnings. So this would have a positive effect on the returns, so not deducted from the 500, additive depending on the sale price and tax rate.

Is it common anywhere to have to pay tax on a land purchase? I don’t recall ever hearing of this.


Same in Bulgaria. Local tax for purchase, goes to the municipality, calculated as a % of the price.