Tax Law Review, Vol. 44, No. 3 (Spring 1989), pp. 349-399

Abstract

Most states that impose income taxes conform their levies to the federal model. Consequently, when income is realized but not recognized at the federal level-for example, when a taxpayer reinvests the gain from the sale of her former residence in a new residence or when a taxpayer realizes gain from the exchange of like-kind property -- states typically follow the federal rule in deferring recognition of that income. On the assumption that state conformity to the federal nonrecognition rules reflects an implicit endorsement of the policies underlying those rules, state deferral ordinarily raises no issue independent of those raised by federal deferral. When nonrecognition transactions have an interstate dimension, however, issues are raised at the state level that are not usually encountered at the federal level. For example, when a taxpayer reinvests the gain from the sale of her former residence in a new residence in a different state or when a taxpayer realizes gain from the exchange of like-kind property through the acquisition of property in another state, one must address not only the question of when income is recognized, but also the question of where it is recognized. This article considers the appropriate state tax treatment of nonrecognition transactions that cross state lines. We examine issues of tax policy and constitutional law raised by such transactions by focusing on two discrete nonrecognition transactions: (1) nonrecognition of gain from the sale of a personal residence by a taxpayer who moves to another state and (2) nonrecognition of gain from the exchange of like-kind property located in different states. Despite the differences between these two transactions, the nonrecognition issues they raise share common themes: whether a state should respect federal nonrecognition rules for transactions with which it has a more limited jurisdictional relationship than does the federal government, and whether the Constitution imposes limitations on a state's power to fashion its own rules in this domain.

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