I sold a life insurance policy with a basis of $39,308, which was the total amount of premiums that I paid while I owned the policy. Coventry Direct, the buyer, paid me $35,000 for the policy and also made a premium payment of $8,411.27 to the insurance company before the sale was completed. They sent me a 1099-LS showing a payment of $43,411.27, which included the premium payment they made. How should I report this transaction on my tax return? Do I have to report the premium payment they made ($8,411.27) as ordinary income? Or do I have to report the difference between my basis and the payment they reported ($43,411.27 - $39,308 = $4,103.27) as a long-term capital gain?
Shouldn't the basis of the life insurance policy be the sum of the premiums paid by me and by the buyer ($39,308 + $8,411.27 = $47,719.27)? If so, then wouldn't I have a long-term loss of $12,719.27 ($47,719.27 - $35,000) that offsets the income of $4,103.27?
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No. You cannot claim what the buyer paid as part of what you paid. This is the buyers cost, not yours. Since you sold to Coventry direct, instead of just cashing in, I am assuming you did not have a cash surrender value on this policy and were not terminally ill. This means that it will be taxed as capital gains, but you will need to do other calculations to figure out your actual cost basis.
If a policy is not a cash value policy, or you do not meet the criteria of the contract, you will need to consider the number of months you held the policy. Your basis in the policy is "equal to the total premiums paid under the contract, less charges for the provision of insurance before the sale" So if your premiums were $145.83 per month for 20 years, then your provision would be $35,000. This means you would subtract $35,000 from the premiums you paid in so your basis would be $0. If you sold half way through a month, or you had premiums paid annually, you would deduct for the months you paid for but were not covered under the policy ( ex. if you paid in January for the full year and sold on March 1st, you would deduct the 10 months you paid for but were not covered.
This means, the $35,000 you received is fully taxable under capital gains tax rules. The rest of your income will play a part in the tax rate. Your tax rate would be between 0% and 20%. The capital gains rates are as follows based on income
To enter your sale of your life insurance, you will take the following steps:
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