Annuities✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
In a tax-free Section 1035 exchange of an annuity, the owner's cost basis in the old contract:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
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.
Why the other options are wrong
- B) The basis is not eliminated; it transfers to the new contract and continues to reduce future taxable amounts.
- C) The basis is not stepped up to account value; such a step-up would permanently erase the deferred gain from taxation.
- D) No gain is recognized at the exchange; tax deferral is the entire purpose of Section 1035.
Memory hook
1035 = the basis hops along to the new contract. Tax is postponed, never erased.