Dr. Hannibal Lecter recently purchased 100% of the stock of the Starling Corporation. Starling was originally started by real estate developer Clarice Starling several years ago as a C corporation. Clarice used the corporation to acquire land, which was very cheap at the time. Over the years, the corporation started to construct buildings on some of the land and then sold the buildings and underlying land to customers. Clarice was an excellent real estate developer and the Starling Corporation made huge profits, most of which were reinvested in the corporation rather than distributed to Clarice. In January of 20x1, Starling converted from a C Corporation to an S Corporation. Starling completed its latest real estate project (Silent Lamb Acres) in 20x2 and was about to sell the buildings and underlying land when Clarice decided to retire and sold her stock in Starling to Lecter. At the time Lecter acquired the stock in the S Corp, it had two major assets:

1) Silent Lamb Acres—a recently completed office park with 100 acres of land and 5 office buildings. Silent Lamb Acres is worth $10 million.

 
2) Red Dragon Acres—Raw land that Starling Corp acquired many years ago for $100,000 and never improved. Red Dragon had a FMV of $1 million at the beginning of 20x1 and is still worth $1 million today. Assume this was the only asset that Starling had when it converted to S status in 20x1.

 
Lecter's plans for Starling Corporation are as follows:

 
1) He intends to sell Red Dragon Acres "as is" (rather than attempting to develop it) for its fair market value of $1,000,000.

 
2) He intends to hold on to Silent Lamb Acres and rent the office buildings to a few large tenants on a triple net lease basis (this means that the tenants have full responsibility for maintaining the property, pay all expenses associated with the property and pay a small rent to Starling Corp every month).


Thus, once Red Dragon is sold, Starling Corporation will basically exist to hold the Silent Lamb Acres office park and collect rents from tenants. It will do little else. Lecter desires to maintain Starling's S corporation status and plans on having the corporation hold on to Silent Lamb Acres for many years to come.


Lecter comes to you, his trusted (and tasty) CPA, and tells you how thrilled he is that Starling Corp is operated as an S Corporation. Because of this, he says that there will only be one layer of tax on the sale of Red Dragon (at the individual level) and he'll be able to have only one layer of tax on the rents he earns on Silent Lamb Acres. Is Lecter right? Identify the tax issues that will face Lecter and Starling Corporation based on Lecter's business plan, citing to sections of the Internal Revenue Code where appropriate. [Note: Assume that Lecter's purchase of 100% of the stock of Starling from Clarice did not change the tax attributes of Starling Corp.]