[Objective] The soil and water conservation benefits and the economic benefits of crop increments in terrace reclamation projects at the small watershed scale in the hilly areas of Southern China were evaluated and optimized, and the trade-off relationship between the conservation benefits and the economic benefits was analyzed in order to provide scientific guidance for the formulation of a spatial optimization layout for the Danjiangkou City, Hubei Province. [Methods] Remote sensing and spatial analysis techniques were used to identify the spatial distribution of terraces in Danjiangkou City and delineate the small watersheds. The Chinese Soil Loss Equation (CSLE) model was combined with field investigations to evaluate the trade-off between soil and water conservation benefits and crop value added when slope cropland was converted to terrace cropland. A linear optimization method was used to determine the optimal spatial layout of the project under multiple scenarios. [Results] The terraces and slope croplands in Danjiangkou City were mainly distributed in the central and northern watersheds and they exhibited higher total benefits in terms of soil and water conservation and value-added economic benefits. The spatial optimization analysis of each small watershed indicated that under the soil and water conservation priority scenario, the changing slope cropland to terrace land project areas were primarily concentrated in the southwestern watershed, whereas under the crop value-added economic benefits priority scenario, the project areas were more heavily concentrated in the central watershed. The linear optimization results under the different scenarios showed a significant trade-off between the soil and water conservation priority and the crop value-added economic benefits priority. Under the different scenarios, the maximum soil and water conservation benefit was an approximately 3.21×10⁶ t reduction in erosion with crop value-added economic benefits of approximately 1.78×10⁸ yuan. The maximum crop value-added economic benefit result was approximately 1.87×10⁸ yuan with soil and water conservation benefits reduced to approximately 3.01×10⁶ t. The Pareto optimal solutions reflected the tradeoff between the two. [Conclusion] The spatial optimization methods used in this study quantified and optimized the trade-off relationship between water conservation benefits and the crop value-added economic benefits in projects where sloping land was converted to terrace land. The results provide a series of non-dominated solutions that can be used to aid government decision-making processes.