## Facts

- In 1991, James F. Davis won \$13,580,000 in the California State Lottery, payable only as 20 annual installments of \$679,000.
- In 1997, Davis entered an agreement with Singer Asset Finance Company, LLC, assigning a portion of his right to remaining lottery installments in exchange for a \$1,040,000 lump-sum payment.
- The Davises’ 1997 federal return treated the transaction as the sale of a long-term capital asset, claiming a long-term capital gain of \$1,032,991 after reporting \$7,009 of attorney’s fees as basis.
- The Commissioner determined the \$1,040,000 was ordinary income, asserting that the assigned right to future lottery payments was not a “capital asset” under I.R.C. § 1221, and issued a deficiency.
- The Davises petitioned the U.S. Tax Court for redetermination.

## Issues

1. Whether the lump-sum payment received for assigning rights to future state-lottery installments is gain from the sale of a “capital asset” under I.R.C. § 1221.
2. Whether the transaction is properly treated as ordinary income because the transferred interest is a right to receive future ordinary income (an anticipatory assignment of income).

## Decision

- The Tax Court held that the right to receive future state-lottery installment payments is not a “capital asset” within I.R.C. § 1221.
- The court sustained the Commissioner’s determination that the \$1,040,000 lump-sum payment was ordinary income in 1997.
- The court rejected the taxpayers’ argument that Arkansas Best required capital-asset treatment for the assigned payment rights.
- The court treated the assignment as an attempt to convert a stream of ordinary income into capital gain, which federal tax law does not permit.

## Legal Principles

- Capital-gain treatment under I.R.C. § 1221 does not apply to a taxpayer’s transfer of a mere right to receive future ordinary income when the transfer functions as an anticipatory assignment of that income.
- A taxpayer generally cannot transform the character of expected ordinary income into capital gain by selling or assigning the right to receive it for a lump sum.
- Arkansas Best addresses whether a taxpayer’s motive for holding property affects capital-asset status; it does not eliminate the distinction between capital assets and claims to ordinary income recognized in prior assignment-of-income authorities.
- State law may determine the existence and assignability of rights, but federal tax law determines the characterization of amounts received from transferring those rights.

## Conclusion

The Tax Court concluded that selling a portion of the right to future lottery installments for a lump sum is treated as the assignment of ordinary-income rights, so the lump-sum proceeds are taxable as ordinary income rather than long-term capital gain.


Davis v. Commissioner, 119 T.C. 1 (2002)