How should an insurance roll-over be treated?

[dschindler1]

We closed an insurance policy and used the all of the cash value to purchase another insurance policy. How do we account for this on our taxes since this should be a roll-over and not income?

[HelenaC]

Your administrator would need to do a 1035 exchange to transfer your original insurance policy to your new insurance policy. The tax code says that the old insurance policy must be exchanged for a new policy—you cannot receive a check and apply the proceeds to the purchase of a new insurance policy.

A 1035 exchange is a rule that permits tax free transfers of “like assets” under the tax code. Like asset in this case means insurance product to insurance product. Specifically under 1035: cash value from a life insurance contract can be exchanged into a new annuity or life insurance.

• You would receive form 1099-R - IRS.gov from your life insurance administrator. 
• Your form 1099-R Box 7 would have Code 6 - Section 1035 exchange (a tax-free exchange of life insurance, annuity, or endowment contracts).
• As you enter your 1099-R, TurboTax will recognize the Code 6- Section 1035 exchange and not tax it. Click on Where do I enter my 1099-R?

[Octopus88]

Here's a further question.  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