575 / When is a policy owner required to recognize gain on the exchange of one annuity contract for another?

If no cash or other non-like kind property is received in connection with an exchange, any gain from the contract surrendered will not be recognized in the transfer to the new contract. Accordingly, the cost basis of the new policy will be the same as the cost basis of the old policy (plus any premiums paid and less any excludable dividends received after the exchange).

If cash or other non-like kind property is received in connection with any of the above exchanges, gain will be recognized to the extent of the cash or other property received as so-called “boot” property.¹ The amount of any policy loan that the other party to the exchange takes property subject to or assumes (reduced by any loan taken subject to or assumed by the first party) is treated as money received on the exchange.² If the owner has exchanged an annuity at a loss, and the requirements of Section 1035 were satisfied, the receipt of boot does not cause the loss to be recognized.³

It should be noted that application of Section 1035 is not an election; its nonrecognition treatment is mandatory when the provisions of that section are met.