Revenue Ruling 2002-75
TAX-FREE EXCHANGE OF ANNUITY CONTRACTS
Released: November 12, 2002
Published: November 12, 2002
Section 1035 - Certain Exchanges of Insurance Policies, 26 CFR 1.1035-1
This ruling states that the transfer of an entire annuity contract into another pre-existing annuity contract qualifies as a tax-free exchange and defines the basis and investment in the contract for the surviving contract.
Is the taxpayer's assignment of an entire annuity contract to a second insurance company, which then deposits the cash surrender value of the assigned annuity contract into a pre-existing annuity contract owned by the same taxpayer, and issued by the second insurance company, a tax-free exchange under Section 1035 What is the basis under Section 1035 and the investment in the surviving contract under Section 72 after the transfer?
A owns Contract B, an annuity contract issued by Company B, and Contract C, an annuity contract issued by Company C. A is the obligee for both contracts. A seeks to consolidate Contract B and Contract C. A assigns Contract B to Company C. Company B transfers the entire cash surrender value of Contract B directly to Company C. Company C includes the transferred cash surrender value of Contract B in Contract C. A will not receive any of the cash surrender value of Contract B that is transferred to Company C and deposited into Contract C. No other consideration will be paid by A in this transaction. The terms of Contract C are unchanged by this transaction, and Contract B terminates.
LAW AND ANALYSIS
Section 1035(a)(3) provides that no gain or loss shall be recognized on the exchange of an annuity contract for an annuity contract. Section 1.1035-1 of the Income Tax Regulations provides that the exchange, without recognition of gain or loss, of an annuity contract for another annuity contract under Section 1035(a)(3) is limited to cases where the same person or persons are the obligee or obligees under the contract received in the exchange as under the original contract.
The legislative history of Section 1035 states that exchange treatment is appropriate for "individuals who have merely exchanged one insurance policy for another better suited to their needs and who have not actually realized gain." H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).
Section 1035(d)(2) cross-references Section 1031 for the rules to determine the basis of property acquired in a Section 1035 exchange. Section 1031(d) provides that property acquired in a Section 1035 exchange has the same basis as that of the property exchanged, decreased by the amount of any money received by the taxpayer and increased by any gain (or decreased by any loss) recognized by the taxpayer on the exchange.
Section 1.1031(d)-1 provides, in part, that in a Section 1035 exchange the basis of the property acquired is the same as the basis of the property transferred by the taxpayer with proper adjustments to the date of the exchange.
Section 72 governs the federal tax treatment of distributions from an annuity contract. For purposes of determining income, gain, or loss from an annuity contract, Section 72 contains two special definitions of investment in the contract. When amounts received are not annuity payments, Section 72(e)(6) defines the investment in the contract. For purposes of Section 72(b), which applies to annuity payments, Section 72(c)(1) defines the investment in the contract in a similar, but not identical, manner.
After completion of the transaction, A owns only Contract C, which has been increased in value to reflect the cash surrender value transferred into it from Contract B. A had no access to the cash surrender value transferred in the exchange. Therefore, this transaction is treated as an exchange that is tax-free under Section 1035.
As a result of the application of Section 1035(d), A's basis in Contract B is included in A's basis in Contract C immediately after the exchange, and under Section 72(c)(1) and Section 72(e)(6), A's investment in Contract B is included in A's investment in Contract C immediately after the exchange.
- The assignment by A of Contract B to Company C for consolidation with pre-existing Contract C is a tax-free exchange under Section 1035.
- After the assignment, pursuant to Section 1035, A's basis in Contract C immediately after the exchange equals the sum of A's basis in Contract B and A's basis in Contract C immediately prior to the exchange.
- After the assignment, A's investment in Contract C under Section 72 equals the sum of A's investment in Contract B and A's investment in Contract C immediately prior to the exchange.
The principal author of this revenue ruling is Ann H. Logan of the Office of Associate Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact her at (202) 622-3970 (not a toll-free call).