What are the requirements for an exchange to qualify as tax-free?

If the exchange involves a life insurance policy, both the old and the new policy must be on the life of the same insured.

For an exchange of an annuity, both annuities must be payable to the same person or persons.

The exchange is handled by the insurance/annuity company. Unlike an IRA or pension you do not have 60 days to rollover the policy proceeds.

Is the exchange still tax-free if cash or other property is received or if there is an outstanding loan?

If cash or other property is received in connection with the exchange, any gain will be recognized to the extent of the cash or other property received.

A policy loan may be treated as cash received unless the new policy is subject to the same loan.

Example:
B has a life policy with a cost basis of $40,000 and a cash surrender value of $100,000. (Unrecognized gain of $60,000) There is an outstanding loan of $20,000. B exchanges this policy for a new policy not subject to the outstanding loan. The outstanding loan is treated as cash received and B will recognize $20,000 of ordinary income. Otherwise, it is a valid 1035 exchange.

The gain is ordinary income, not capital gain.

Can a fixed annuity be exchanged tax-free for a variable annuity? Can a whole life insurance policy be exchanged tax-free for a variable life insurance policy?

Yes.

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