567 / Is a deductible loss sustained under a straight life annuity if the annuitant dies before payments received by the annuitant equal the annuitant’s cost?

If the annuitant’s annuity starting date is after July 1, 1986, a deduction may be taken on the individual’s final income tax return for the unrecovered investment in the contract remaining on the date of death.¹ Similarly, a refund beneficiary may deduct any unrecovered investment in the contract that exceeds the refund payment.² For purposes of determining if the individual has a net operating loss, the deduction is treated as if it were attributable to a trade or business.³

If an annuitant’s annuity starting date was before July 2, 1986, there is no deductible loss; the view under the law at the time was that the annuitant had received all that the contract required.⁴ For example, no loss deduction was allowed where a husband purchased a single premium nonrefundable annuity on the life of his wife and his wife died before his cost had been recovered. The deduction was disallowed on the ground that the transaction was not entered into for profit.⁵ Legislatively, the denial of a deductible loss for unrecovered investment at death was viewed as a trade-off for the fact that exclusion ratio non-taxable payments also could continue beyond the point of fully recovering cost basis for contracts before July 2, 1986.