Section 1031: We Don't Need Another Hero
Southern California Law Review, Vol. 60, p. 397, 1987
55 Pages Posted: 31 Jul 2009
Date Written: 1987
This Article critiques current Internal Revenue Code section 1031 which provides for the non-recognition of gain on the exchange of “like-kind” property. Part I begins with a chronological history of Section 1031 and a summary of the traditional rationales for the section and the acknowledged flaws in those explanations. It then proceeds to an in depth analysis of several hypotheses as to the section's origins. Part I concludes that several factors collectively led to the enactment of section 1031, including confusion about the realization doctrine, a sympathy for a consumption tax, reflected in a variety of ways, and a conscious decision by Congress to use the tax laws to promote economic growth.
Part II evaluates the unintended effects, both positive and negative, of the provision. It concludes that any benefits of section 1031 are attained only at a high cost. The section is inequitable, inefficient and contradicts our present notions of income. Furthermore, its benefits can be better achieved, at less cost, through other methods. Consequently, the provision should not remain in the Code in its present form.
The proper form of section 1031 depends both upon close analysis of economic and equitable considerations, and upon administrative and political practicalities. The most important choice is whether to retain an income tax or switch to a consumption-based tax. If Congress decides to switch to a consumption-based tax, then section 1031 is not needed at all. An expenditure tax is the ultimate section 1031 since all investments (whether like-kind or not) result in deferral. Section 1031 is simply subsumed by the tax. If Congress retains an income tax, several possibilities exist. The most extreme is complete abolition of the section. Even if this were accomplished, however, a narrow range of exchanges would still be nontaxable under the basic sales and exchange provision of section 1001. Less extreme options include using a section 1033 functional similarity test for non-recognition exchanges or providing lower rates for all investment rollovers.
The inconsistencies within section 1031 reflect both the often poorly understood nature of these factors and the political compromise necessary to enact the law. The original factors involved in its enactment, confused to begin with, do not stand up against today's concepts of income, nor against sixty years of experience with the section. Section 1031 is inefficient, inequitable, and a revenue loser. The section should be repealed or drastically altered.
Keywords: Legal History, Like-Kind Exchanges, Non-recognition, Section 1031, Taxation, Tax Reform
Suggested Citation: Suggested Citation