281 / Is the transfer of a life insurance policy subject to a nonrecourse loan a transfer for value that could cause the loss of income tax exemption for death proceeds?

Since a transfer of a policy subject to a nonrecourse loan discharges the transferor of obligations under the loan, the transferor is treated as receiving an amount equal to the discharged obligations.¹ Thus, there may be a transfer for value when a life insurance contract is transferred that is subject to a policy loan. Nonetheless, where the value of a policy exceeded the outstanding loan, a transfer was ruled in part a gift and within one of the exceptions to the transfer for value rule because the basis of the policy in the hands of the transferee was determinable in part by reference to the basis of the policy in the hands of the transferor ( Q 279).²

In Letter Ruling 8951056, the IRS found that the gratuitous transfer of a policy subject to a nonrecourse loan was held part gift, part sale. Because the transferor’s basis was greater than the amount of the loan, the basis of the policy in the hands of the transferee was the basis in the hands of the transferor at the time of transfer and thus the transfer fell within the same exception to the transfer for value rule.³

1.     Treas. Reg. § 1.1001-2(a).