QUESTION 31

1. Biff and Buffy are real estate speculators each of whom over the past 10 years have bought and sold vast acres of unimproved land in Temecula, Lake Elsinore and Hemet. Their most recent purchase is dry lake bottom in Elsinore. Biff and Buffy together with Regina, a tax lawyer, and Dirk and Edward, cosmetic surgeons, purchased the Elsinore land. On advice of Regina, they transferred the land to a newly formed S Corporation. They had held it for two years during the Riverside County land recession and made no effort to sell it. After holding the land for six years, the S Corporation sold 1/3 for a $100,000 gain and then the remaining 2/3 for a $300,000 gain. The sales were on the installment method and as the corporation collected the money it was invested in Elsinore Water District bonds.

   	a.	The gain on the sale of the land is most likely capital gain at the corporate level and flows through to the shareholders with the same character.
   	b.	The gain on the sale flows through as ordinary income to Biff and Buffy with capital gain to the remaining shareholders.
   	c.	Since the corporation was formed to convert ordinary income for some shareholders to capital gain, the gain is ordinary income to all shareholders.
   	d.	None of the above.

QUESTION 32

1. Sixteen years ago, Biff, Buffy, and Buffy, Jr. organized Beach Wear Inc. (BWI) to sell beach wear throughout California. The sole class of common stock of BWI is owned by Buffy (60%) and her husband, Biff (20%), and Buffy, Jr. (20%). On December 1 of the tax year specified for the exam, BWI files an S election. As of December 31 of that same tax year, BWIs balance sheet includes the following:

   Asset AB FMV

   Accounts Receivable $ 0 $300,000

   Payments Due Under

   Installment Sale $450,000 $600,000

   Machinery $ 0 $225,000

   During the next tax year, BWI collected the accounts receivable receiving $300,000. BWI also collected the one of two payments still due on the installment sale of $300,000. BWIs taxable income for the same tax year is $900,000.

   	a.	There is no built-in gain.
   	b.	There is built-in gain of $675,000 of which $375,000 was recognized in the next tax year (after the tax year specified for the exam).
   	c.	The flow-through of the built-in gain to Buffy is $225,000.
   	d.	None of the above.