Reform Proposals

This chapter describes the principal proposals from their primary documents and identifies the design questions each would put to the people who would have to administer it. Chapter 62 explains how the proposals were scored, and revenue figures appear here only where they illuminate design.

64.1 Outright repeal

The 2013 Senate Finance staff draft. On November 21, 2013, Senate Finance Committee Chairman Max Baucus released a staff discussion draft on cost recovery and tax accounting. It would have struck section 1031 for exchanges made in taxable years beginning after December 31, 2014.¹ The repeal was part of a larger design. The draft would have created a pooled asset cost recovery system, and the staff summary explained that for pooled assets the deferral inherent in pooling would replace the like-kind rules. The summary acknowledged that the draft offered no analog for real property or intangible property, and it asked for comment on whether the like-kind rules should be retained for those assets and, if so, whether the like-kind standard should give way to a similar use concept of the kind found in the involuntary conversion rules.²

The 2014 Camp bill. House Ways and Means Committee Chairman Dave Camp released the Tax Reform Act of 2014 as a discussion draft on February 26, 2014, and introduced it as H.R. 1 on December 10, 2014.³ Section 3133 of the bill would have struck section 1031 for transfers after December 31, 2014, except for a transfer under a written binding contract entered into before January 1, 2015, as part of an exchange completed before January 1, 2017.⁴ The conforming amendments show that repeal involves more than deleting a section. The boot, loss, and basis rules of section 1031(b) through (d), which also govern the exchanges described in sections 1035 through 1037, would have been rewritten into section 1035. The recapture exceptions in sections 1245(b)(4) and 1250(d)(4) would have dropped their references to like-kind exchanges. Provisions that look back to a past exchange, including the residence rule in section 121(d)(10), would have referred to section 1031 as in effect before its repeal.⁵ The Joint Committee scored the repeal at $40.9 billion over ten years.⁶ Neither the Baucus draft nor the Camp bill was enacted, and the 2017 Act took the narrower path described in 64.3.

The academic case. The scholarly argument for repeal is older than either draft. Jensen found the traditional justifications for nonrecognition wanting, although he concluded that the provision has some plausibility for traditional simultaneous exchanges.⁷ Kornhauser traced the provision's origins and concluded that whatever benefits it produces come at a high cost.⁸ Johnson's 2008 proposal would have repealed nonrecognition of gain and required the exchange intermediary to file an information return reporting the amount realized, on the reasoning that valuation, the historical justification, is not difficult when an intermediary receives a cash price.⁹ Schnee and Stinson recommended elimination and, as a fallback, proposed limits aimed at investment property, qualified intermediaries, and dual-use property.¹⁰

Transition design. Repeal would present three transition questions, and the texts answer them differently.

The first is which event triggers the new rule. The Camp bill keyed repeal to transfers after its effective date, the Baucus draft to exchanges made in taxable years beginning after its date, and the 2017 Act, for personal property, to exchanges completed after December 31, 2017, with an exception for any exchange in which the relinquished property was disposed of, or the replacement property received, on or before that date.¹¹ A deferred exchange straddles two dates by design, so the choice decides whether an exchange that is in its identification period on the effective date survives.

The second is what happens to arrangements already in place. A binding contract rule protects negotiated sales, but a reverse exchange in which replacement property is already parked with an accommodation titleholder (Chapter 30) is neither a contract to sell nor a completed exchange, and none of these texts addresses it by name.

The third is what happens to gain already deferred. Repeal would not tax gain deferred in earlier exchanges. That gain remains in the basis of property the taxpayer already holds, which is why the Camp bill preserved references to section 1031 as in effect before its repeal.

64.2 Annual deferral caps

The first version. The fiscal year 2015 budget proposed limiting the capital gain deferred under section 1031 from exchanges of real property to $1,000,000 per taxpayer per taxable year, indexed for inflation, and would have given Treasury regulatory authority to implement the limit, including rules for aggregating multiple properties exchanged by related parties.¹² The stated reasons were that deferral for real property had little justification; that valuation, the primary historical justification, had limited appeal when qualified intermediaries sell the relinquished property and acquire the replacement property; and that the ability to exchange unimproved for improved real estate encouraged permanent deferral. The cap was described as preserving the ability of small businesses to continue current practices.¹³ The fiscal year 2016 version added a rule making art and collectibles ineligible, and the fiscal year 2017 version extended the $1 million cap to all gain deferred under section 1031.¹⁴

The later version. From fiscal year 2022 through fiscal year 2025, the budget carried a proposal titled "Repeal deferral of gain from like-kind exchanges" that would in fact have allowed deferral of up to $500,000 of gain per taxpayer each year ($1 million for married individuals filing a joint return) on like-kind exchanges of real property. Gain above that amount would be recognized in the year the taxpayer transfers the real property subject to the exchange.¹⁵ The stated reasons were that treating exchanges like sales would reduce distortions, raise revenue, increase the progressivity of the tax system, and align the treatment of real property with other property.¹⁶

What the proposals leave open. A cap is simple to state and hard to administer, and none of the proposals addresses the questions that would dominate its regulations.

Who the taxpayer is. A partnership is the exchanging taxpayer when it holds the property (Chapter 50), but a per-taxpayer cap with a joint return amount is framed for individuals. The earlier proposals delegated aggregation rules for related parties; the later text does not mention pass-through entities or aggregation.¹⁷ A cap applied at the entity level invites fragmentation of ownership, and a cap applied at the owner level requires allocating an entity's deferred gain among owners with different remaining capacity.

Which exchange uses the cap. An individual with several exchanges in a year needs an ordering rule, and exchanges that close in different taxable years complicate it. The later proposal recognizes excess gain in the year of the relinquished transfer, but in a deferred exchange that begins late in a year the amount of gain eligible for deferral may not be known until the replacement closes in the following year, a timing problem the current rules address for boot by allowing installment reporting in qualifying cases (Chapter 44).

Basis and character. The existing basis rule already accommodates partial recognition, because the basis of replacement property is increased by gain recognized on the exchange. Character is harder. Where the relinquished property has depreciation that would produce recapture on a sale, a cap must say whether gain recognized because of the cap is taken into account under the like-kind recapture rules in the same way as gain recognized because of boot, and neither version says.¹⁸

Multiplication. A per-taxpayer cap rewards dividing ownership among family members or entities before an exchange. The earlier proposal's delegated aggregation authority addressed that incentive, while the later one would have left it to general doctrines such as step transaction (Chapter 42).

Indexing. The earlier cap was indexed for inflation, and the later text does not mention indexing.¹⁹

The fiscal year 2015 cap was scored at $18.3 billion over ten years, and the later $500,000 cap at between $18.6 billion and $19.7 billion, depending on the budget year.²⁰

64.3 Restriction by property type or taxpayer class

Congressional narrowing by type. Congress has narrowed section 1031 three times. The Deficit Reduction Act of 1984 rewrote subsection (a), adding the list of excluded property now in paragraph (2), which brought partnership interests within the exclusions, and the identification and exchange periods now in paragraph (3).²¹ The Omnibus Budget Reconciliation Act of 1989 added subsections (f) through (h), including the related party rules and the rule that real property in the United States is not of like kind with real property outside it.²² The 2017 Act limited section 1031 to real property not held primarily for sale.²³ Chapters 20, 40, and 48 discuss the first two changes, and Chapter 14 the consequences of the third.

Proposals aimed at particular property. The fiscal year 2016 and 2017 budgets would have made art and collectibles ineligible, a proposal the 2017 Act made moot by ending exchanges of personal property altogether.²⁴ The Baucus staff summary pointed to a different kind of restriction. Instead of narrowing the eligible property, it would have narrowed the required relationship between the old and new property by replacing like kind with a similar use standard of the kind that governs involuntary conversions. For real estate the difference would be large. Under the like-kind regulations the fact that real estate is improved or unimproved is not material, while replacement property after an involuntary conversion generally must be similar or related in service or use, subject to the special like-kind rule for condemned business or investment real property (Chapter 45).²⁵

The cost of drawing lines. Every restriction by type creates a boundary to litigate. Limiting section 1031 to real property made the definition of real property decisive, and Treasury answered with regulations in 2020 (Chapters 14 through 16). The reach of those regulations' State and local law test is still unsettled (66.3).²⁶

Restriction by class of taxpayer. This chapter did not locate a federal proposal that would deny section 1031 to a class of taxpayers defined by entity type. Caps operate as class restrictions by size, and the fiscal year 2015 proposal described its cap in those terms, as preserving current practice for small businesses.²⁷ California drew an income line in the opposite direction. From 2019 until taxable years beginning in 2025, it applied the federal real property limitation only to individuals with adjusted gross income of $250,000 or more on an individual return, or $500,000 or more on a joint, head of household, or surviving spouse return, so that other individuals could continue to exchange personal property for California purposes (Chapter 57).²⁸

The Billionaires Income Tax Act, introduced in September 2025, would restrict section 1031 by class most directly. An applicable taxpayer is, in general, an individual whose applicable adjusted gross income exceeded $100 million, or whose covered assets exceeded $1 billion, in each of the three preceding taxable years. For such a taxpayer, an exchange to which section 1031 applies would be a disregarded nonrecognition event, and gain would be recognized as if the property had been sold for its fair market value immediately before the transfer (64.4).²⁹

64.4 Interest charges on deferred tax

The idea. A charge for the time value of deferred tax would leave the reinvestment function of section 1031 intact while removing most of its value as a deferral. The exchanger would still reinvest the whole of the proceeds, and the Treasury would be compensated for waiting. The Code already contains three working versions of the idea.

Installment sales. Section 453A imposes interest on the deferred tax attributable to installment obligations arising from sales of property for more than $150,000, but only when the face amount of such obligations that arose during the year and are outstanding at its close exceeds $5,000,000. The interest is an applicable percentage of the deferred tax liability, which is the unrecognized gain multiplied by the maximum rate of tax, multiplied by the underpayment rate, and it is added to the tax for each year the obligation remains outstanding (Chapter 44).³⁰

Passive foreign investment companies. Section 1291 allocates an excess distribution, or gain on a disposition, ratably over the shareholder's holding period, taxes the amounts allocated to earlier years at the highest rate for those years, and adds interest on those increases in tax.³¹ The regime taxes on realization but charges for the deferral that preceded it.

Long-term contracts. Under the look-back method of section 460(b), a taxpayer using the percentage of completion method pays or receives interest when a contract is completed, correcting for the timing of income reported on the basis of estimates.³²

A foreign model. Germany charges for deferral only when reinvestment fails. A taxpayer who forms a reinvestment reserve under section 6b of its Income Tax Act and dissolves the reserve without a corresponding reinvestment must increase profit by 6 percent of the dissolved amount for each full year the reserve existed (Chapter 65).³³

Academic and legislative designs. Auerbach proposed a retrospective capital gains tax that taxes gain only on realization but effectively charges interest on past gains when realization occurs. The design removes the advantage of deferral and the lock-in that follows from it, and unlike an earlier proposal by Vickrey it does not require knowledge of the pattern of gains over time.³⁴ The Billionaires Income Tax Act adapts that approach for assets that cannot be marked to market. When an applicable taxpayer transfers a nontradable covered asset, including in a section 1031 exchange, gain is recognized and the tax is increased by a "deferral recapture amount," computed as interest on the tax deemed attributable to gain allocated to earlier years and capped at a percentage of the gain.³⁵

Design questions. An interest charge on section 1031 deferral would require choices that these models make differently.

When the charge is paid. Section 453A charges annually, which requires cash that an exchanger who has reinvested everything may not have. Section 1291 and the Billionaires Income Tax Act charge on realization, which requires tracking gain and holding periods through a chain of exchanges that may span decades.

The rate. Section 453A uses the underpayment rate.³⁶ A rate closer to the government's borrowing cost would track the Treasury's actual cost of waiting (62.2).

Death. A charge collected at the final disposition disappears if the chain ends with a basis step-up at death. An interest charge works only if it is paired with a realization rule at death or collected before death (64.5).

Threshold. Section 453A shows how a threshold can confine the charge to large deferrals and leave ordinary transactions alone. A threshold combined with an interest charge would be more precisely targeted than a cap that forces recognition, because it prices deferral above the threshold instead of prohibiting it.

64.5 Mark-to-market and constructive realization alternatives

Constructive realization in current law. The Code already departs from realization in defined settings. A dealer in securities marks securities held at the end of the year to market.³⁷ Section 1256 contracts are treated as sold at year end, with gain or loss treated as 60 percent long-term and 40 percent short-term.³⁸ An appreciated financial position is treated as sold when the taxpayer enters into a constructive sale.³⁹ All property of a covered expatriate is treated as sold on the day before the expatriation date, subject to an exclusion amount.⁴⁰ Of these rules, only the expatriation rule reaches real property directly, and it is the one existing rule that can tax gain deferred through a chain of exchanges without a sale.

Realization at gift or death. From fiscal year 2022 through fiscal year 2025, the budget proposed treating transfers of appreciated property by gift or at death as realization events. The fiscal year 2022 version would have excluded, among other things, transfers to a U.S. spouse or to charity, which would carry over basis; tangible personal property other than collectibles; gain on residences up to $250,000 per person; and a further $1 million of gain per person, indexed and portable to a surviving spouse. It would have deferred the tax on certain family-owned businesses and allowed a 15-year payment plan for illiquid assets transferred at death. It would also have required a trust, partnership, or other noncorporate entity to recognize gain on property that had not been the subject of a recognition event in the prior 90 years, with the first possible recognition date December 31, 2030.⁴¹ The fiscal year 2025 version raised the general exclusion to $5 million per person, portable to a surviving spouse, and moved the first 90-year recognition date to December 31, 2033.⁴²

For section 1031 this is the proposal that matters most. The planning described in Chapter 46, holding exchange property until death so that the deferred gain is eliminated by the basis rule of section 1014, would end for gain above the exclusions.⁴³ Exchanges would still defer tax during life, but the deferral would end at the owner's death, and its present value would fall accordingly.

A minimum tax that includes unrealized gains. The fiscal year 2023 budget proposed a minimum tax of 20 percent on total income, generally inclusive of unrealized capital gains, for taxpayers with wealth greater than $100 million, with payments treated as prepayments creditable against later tax on realized gains. The fiscal year 2024 and 2025 budgets raised the rate to 25 percent.⁴⁴ Because the base generally included unrealized gains, nonrecognition in an exchange would not by itself have kept appreciation out of the minimum tax for a covered taxpayer.

Annual marking for the wealthiest. The Billionaires Income Tax Act would apply two regimes to applicable taxpayers. A tradable covered asset held at the close of a taxable year would be treated as sold, as would a tradable covered asset transferred in a disregarded nonrecognition event. A nontradable covered asset would be taxed when transferred, with the deferral recapture amount described in 64.4, and a section 1031 exchange would be such a transfer.⁴⁵

The constitutional question. An annual tax on unrealized appreciation would raise the question the Supreme Court reserved in Moore v. United States. The Court upheld the mandatory repatriation tax on the reasoning that Congress may attribute a corporation's realized and undistributed income to its shareholders, and it did not decide whether realization is constitutionally required (66.5).⁴⁶

What the alternatives imply for section 1031. Mark-to-market regimes and minimum taxes aimed at the wealthiest taxpayers would leave the provision untouched for everyone below their thresholds. Realization at death would change it for every exchanger whose deferred gain exceeds the exclusions. Of the families of proposals in this chapter, it is the one that would most change how exchanges are planned, because it reaches the endgame rather than the exchange.