United States V. Davis - Overruled By Congress

Overruled By Congress

In response to this decision, Congress enacted Internal Revenue Code § 1041. This statute provides that, generally, "no gain or loss shall be recognized on a transfer of property from an individual to...(2) a former spouse, but only if the transfer is incident to divorce."

While this statute overrules the specific holding of Davis, it does not change the general rule—that "a taxpayer recognizes a gain on the transfer of appreciated property in satisfaction of a legal obligation."

These legislative changes were regarded by most tax specialists as overdue and welcome, because the David/Farid rule had a number of weaknesses:

• It had been a complicating factor in divorce settlements
• It resulted in better treatment for residents of community property states (since the Service had held that it would not apply Davis to an equal division of community property) that for residents of common law jurisdictions.
• It added considerably to the Treasury's enforcement burden—the Treasury ran the risk that gain would be reported by neither spouse, unless it was prepared to audit every substantial property settlement:

• transferor-spouses sometimes seemed not to know about Davis or to find it counter-intuitive, and hence often omitted to report their taxable gain when property was transferred.
• By contrast, transferee-spouses, well aware of Farid, almost invariably computed their gain(loss) on subsequent sale by using a basis equal to fair market value at time of receipt.