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THE UNITED STATES TAX SYSTEM: AN OVERVIEWOver time, then, the value (and accessions to wealth) of property of a taxpayermay change. Coupled with that is the fact that the federal income tax systemutilizes an annual accounting period for purposes of accounting and taxingincome. Each year, a taxpayer may have an increase or decrease in wealth due tothe real or nominal change in the value of property held by the taxpayer.Although changes in value occur over time, and can be measured annually,the income tax system does not attempt to track, measure, and tax economicgain (or loss) annually. Instead, gain (or loss) is accounted for only when sometransactional event occurs: namely, a sale, exchange, or other disposition ofproperty. The tax on gains (or losses), then, is a transactional tax, not an economictax.Realization denotes the transactional event giving rise to gain (or loss) forincome tax purposes. The event is a sale, exchange, or other disposition of property.An event giving rise to realization occurs when property is sold for money, whenproperty is exchanged for other property, or when property is given in exchangefor the satisfaction of some contractual obligation. A contractual obligation is avaluable property right; its exchange—the satisfaction of a contract right—forother property is a transactional disposition within the contemplation and reachof the gain provisions of the federal tax law.Questions arise as to whether a particular event or transaction is a realizationof income, and as to when (in which tax year) the realization event occurred.(f) RecognitionOnce an element of gain is realized, the next step is to determine whether suchgain will be recognized and subject to income taxation. Under the federal taxlaw, the general rule is that the “entire amount of gain or loss . . . on the sale orexchange of property shall be recognized.” 56 Recognition is the process of takinggain into account for income tax purposes. The gain is recognized and subject tocurrent taxation, unless a deferral is permitted.Under the federal tax law, the deferral of realized gain (or loss) is termednon-recognition. For various policy reasons, Congress has granted a deferral intothe future of a currently realized gain. The federal tax law contains a number ofnon-recognition (nontaxable) provisions. 57 The best-known non-recognition provisionsare the following.Like-Kind Exchanges. 58 Non-recognition is allowed (with some exceptions andunder certain conditions) for exchanges of property held for investment, or propertyused in a trade or business, when such property is exchanged only for propertyof a like kind to be similarly held for investment, or used in the trade orbusiness. The idea is that gain should not be recognized and taxed in a transactionin which the character of the property remains essentially unchanged. Property isconsidered to be essentially unchanged if property of a like kind is substituted inits place.56 IRC § 1001(c).57 IRC §§ 1031–1042.58 IRC § 1031. 44