losses are capped and delayed. To provide some degree of fairness to the original tax program, six years later the U.S. Supreme Court ruled that a capital gain cannot be taxed until a taxpayer actually realizes the income from the sale of the asset. 3 By 1921, Congress enacted the original law establishing “non-recognition” of income in a property transaction. Put simply, the government established the legal foundation for not recognizing a taxpayer’ capital gain as being taxable under certain conditions. This law migrated through three different sections of the U.S. codes before settling in 1954 on §1031 of the Internal Revenue Code. The original wording was limited and not entirely clear, creating volumes of judicial interpretation between the 1930s and 1990s. Much of what we consider “§1031 law” came more from the courts than from Congress. 4 The core reasoning for non- recognition of gain in a §1031 exchange — continuation of investment — is sensible and straightforward, dating back to a 1934 report from the House Ways and Means Committee: “[I]f the taxpayer’s money is still tied up in the same kind of property as that in which it was originally invested, he is not allowed to compute and deduct his theoretical loss on the exchange, nor is he charged with a tax upon his theoretical profit. The calculation of profit or loss is deferred until it is realized in cash, marketable securities, or other property not of the same kind having a fair market value.” 5
IF WE RECOGNIZE A GAIN ON AN ASSET WHOSE VALUE MERELY KEPT UP WITH INFLATION, WE HAVE NOT TRULY EXPERIENCED THE GAIN. YET WE ARE TAXED AS IF WE HAD.
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