38 / How is gain on the sale of a cash value life insurance policy calculated after 2008? How did the 2017 tax law change the rules governing gain on the sale of a life insurance policy?

Editor’s Note: The 2017 tax reform legislation reversed the IRS position in Revenue Ruling 2009-13, and instead now provides that in determining basis, no adjustment is made for mortality, expense or other reasonable charges incurred under the contract (the “cost of insurance”) in the case of a policy sale. Therefore, on sale of a cash value insurance policy, the insured’s basis is no longer reduced by the cost of insurance.¹ This new rule for determining basis is effective retroactively, to transactions entered into after August 25, 2009.²

Revenue Ruling 2009-13 explained how to calculate the amount and character of gain upon the surrender or sale of a life insurance policy by the insured.³ The example below illustrates the results upon the sale of a cash value life insurance policy (Situation 2) prior to the clarification that reversed this position in the 2017 tax reform legislation. For examples illustrating the results upon the surrender of a cash value policy (Situation 1) and the sale of a term life insurance policy (Situation 3), see Q 37 and Q 39.

Revenue Ruling 2009-13: Situation 2

In Situation 2, the IRS took the position that the cost of insurance protection must be subtracted from the premiums paid when determining the adjusted basis in the contract. The 2017 tax reform legislation reversed this IRS position retroactively, for transactions entered into after August 25, 2009.