Section 1035 Exchange (Taxation)
A tax-free exchange among life policies, endowments, annuities, or qualified LTC contracts, preserving basis and avoiding gain recognition when executed insurer-to-insurer.
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Practice This Concept
Under IRC Section 1035, which exchange of contracts is generally tax-free?
Exchanging a life insurance policy for another life insurance policy, or a life policy for an annuity — Section 1035 permits tax-free exchanges of: life insurance for life insurance, life insurance for an annuity, and annuity for annuity — provided the insured/annuitant is the same and the exchange is direct. An annuity may NOT be exchanged tax-free for a life insurance policy, and a surrender-then-repurchase is a taxable event. The exchange must be property-for-property, same owner.
National insurance concept
In a tax-free Section 1035 exchange of an annuity, the owner's cost basis in the old contract:
Carries over to the new contract — In a Section 1035 exchange, no gain or loss is recognized, and the cost basis in the old contract carries over to the replacement contract. When the new contract is eventually distributed, the carried-over basis reduces the taxable amount under the exclusion ratio or the LIFO withdrawal rules. Because the basis transfers, the tax on the deferred gain is postponed rather than forgiven.
National insurance concept
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