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1035 transfer and sale of home

 I did a 1035 rollover of the cash value in my life policy to an annuity.  The cash value was about $28,000.  However, when I first had the policy, I contributed premiums in a total amount of about $80,000.  This is a difference of about $52,000.  Shortly after the transfer, I took $12,000 out of the annuity amount, leaving about $16,000 in the annuity, and now a cost basis of about $68,000.  If I cashed out the annuity at some point, I believe I could claim the $52,000 as a capital loss and, as an example, if I sold my house for a gain exceeding $250,000, could apply that capital loss to the proceeds from sale of the house, to reduce my liability for the amount exceeding $250,000.  I hope I have explained that clearly.  Is what I am stating true?  Is that something I could do with the capital loss from cashing out the annuity when there is a $52,0000 difference between the cash that was originally put into the life policy and the cash value when I closed it and did the 1035 transfer?  Rick

1 Reply
Employee Tax & Finance Expert

1035 transfer and sale of home

These are two separate issues.


The home exclusion of $250,000 reduces the gain on the sale of the home included in your taxable income. Any capital losses reduce your total taxable income.


This is from a previous post in 2020:


As you suggest, there is a way to possibly use this to your advantage by declaring the variable annuity a "loss" and using this to reduce your income taxes.


First, you have to sell or surrender the annuity. To calculate your gain or loss, you have to figure your "cost basis." This is the total amount of principal you contributed, minus any withdrawals you made. From this, subtract the proceeds from the sale. If you paid a surrender charge, you have to add this back in.


Using an example, we'll assume your total contribution to your variable annuity was $80,000, that you took $15, 000 in withdrawals, that the annuity is worth $60,000 on the day you cash it out, and that you have to pay a $2,000 surrender charge for canceling the contract early.


Although you receive a check for $43,000  ($60k - $15k - $2k , your reportable loss is $5,000  ($80k-#15K-$60k) -- not $7,000. The $2,000 surrender charge is not considered part of your loss. One bright spot: even if you are under age 59 1/2, there will be no 10% early withdrawal penalty from by the federal government because, as mentioned above, this is only imposed on gains.


Now here's where we enter the "murky" zone: Where on your tax return do you report this loss?

A loss on a variable annuity is not considered an "investment" loss. You cannot use it to offset income from investments such as mutual funds or the profit you realized from the sale of stock. Instead, it is classified as an "ordinary" loss, which means it is (potentially) fully deductible in a single tax year.


As a miscellaneous itemized deduction - it would not be deductible due to changes in the tax laws -  the conservative approach. Now here's the more gutsy approach: Instead of listing your annuity loss as a non deductible expense some tax experts think it is more appropriate for it to be listed under "Other Gains/Losses"   schedule 1 line 4  sure you seek the help of an experienced tax professional and investment advisor.


The aggressive approach is based on Revenue Ruling 61-201, 1961-2, CB46. 

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