New construction/capital gains/death of parent- need tax advice

[Mike Shahi]

Hope all is well. My parents own a home in MD and owe about 500k on it. As is, the home can sell for 1.1/1.2. The home was purchased in 2008 for 700k. 

Mom passed away last year unexpectedly. Now, Dad and I are trying to figure out our next move. Sell the house as is or use the lot to build new construction and sell for 2.5+. The all in price would be around 1.5. (Cost of construction and payoff of remaining loan on the home)

1- selling the home as is would help on capital gains tax. Dad would automtically get the 500k exclusion since Mom passed away. We have two years from date of death to take advantage of this loophole.  I'm also reading about a step up basis which would pretty much make capital gains tax my Dad would owe, zero. Mom's 50% and Dad's 50% of fair market value. I think it would put the cost basis at 850k. If the home sells for 1.2, that puts him below the 500k capital gains tax exclusion so he walks away with a nice profit and no tax. Please correct me if I'm wrong, thats why I'm here

2- Tear the house down and put up new construction. Since the loan on the house will need to be payed off before construction begins, it means the new loan will be solely under my Dad's name- and since he will not reside in the property, it is now seen as an investment property. Dad will now only qualify for 250k capital gains tax exclusion and will probably end up having to pay taxes that eats up the profit. I'm doing the math and after a sale price of 2.5 minus holding costs, agent fees, capital gains tax, it wouldn't make sense for us to wait 15 months to walk away with around 600k profit. We can make that now selling the home as is. 

Am I missing something? Please provide any input. Thanks all for your help and guidance