CCA 200851060: Life for life qualifies under 1035 so long as the insured stays the same

Plain-English summary

A one-paragraph answer with a referral attached, followed by shop talk.

Section 1035 lets a policyholder trade one insurance or annuity contract for another without paying tax at the moment of the swap. It is a nonrecognition rule: the gain built up inside the old contract is not taxed on the exchange but carries over into the new one, so the tax is deferred rather than forgiven. The point of the provision is that a policyholder who moves to a different contract of the same kind has not cashed out, and should not be taxed as though they had.

The question was whether the provision reaches an exchange of one life insurance contract for another, and the answer is that it does. The writer says they believe section 1035 also covers a policyholder exchanging one life insurance contract for another life insurance contract, provided the insured is the same person under both contracts, citing section 1035(a)(1) and Treas. Reg. 1.1035-1. The condition is the operative part. Nonrecognition here rests on continuity, and a contract on a different life is a different risk on a different person, not a continuation of what the policyholder held. Change the insured and the exchange falls outside the rule.

The writer does not present this as settled from their own desk. The answer is prefaced "I believe," and they recommend calling a named assistant chief, on the ground that colleagues who recently worked some section 1035 projects may have more up to date information than the writer possesses. Read as a pointer to the right people, not as a considered position.

The closing paragraph is unrelated to the question and is left in the release. The writer asks whether the reader has been following the variable annuity CARVM or PBR proposals on the computation of life insurance reserves, and would be interested in their views. Both acronyms refer to methods for valuing the reserves a life insurer must hold, which were under active reconsideration at the time. The release does not expand either one or say anything about their tax treatment.

This is a clean digital release rather than a scan, so no OCR correction was needed. Kept as released: the bare "1035(a)(1)" and "1.1035-1" without "section" or "Treas. Reg."; the acronyms "VA CARVM" and "PBR" unexpanded; "re the computation"; the hyphen after the greeting; and "thereon" in the closing sentence.

Ruling snapshot

• Question: Does section 1035 cover the exchange of one life insurance contract for another life insurance contract?
• Outcome: Advice given, hedged and referred on. The writer believes it does, provided the insured is the same person under both contracts, and recommends calling colleagues who recently worked section 1035 projects and may hold more current information.
• Key authorities: IRC section 1035(a)(1); Treas. Reg. 1.1035-1.

Full text (IRS public release)

ID: CCA_2008100807382221 Number: 200851060
Office: ---------- Release Date: 12/19/2008

UILC: 1035.00-00

From: ------------------
Sent: Wednesday, October 08, 2008 7:38:29 AM
To: ------------------
Cc: -------------------------------------
Subject: RE: 1035 exchanges

Hi ------- -

I believe 1035 also covers a policyholder's exchange of one life insurance contract for another life insurance contract, provided the insured is the same person under both contracts. See 1035(a)(1) and 1.1035-1.

I recommend you give -----------------, the Assistant Chief of the ---------------------------------, a call (-------------
-------). I believe ------- and ----------------recently worked some 1035 projects and may have more up-to- date information than I possess.

Hope everything is going well for you. Have you been following the VA CARVM or PBR proposals re the computation of life insurance reserves? If you have any views on either proposal, I would be interested in hearing your thoughts thereon.

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