Chapter 13: Nontaxable Exchanges

01.Core Concepts

• When an insurance product that would be tax free is exchanged for an insurance product that creates ordinary income, there is no immediate recognition of gain. • Example: Johnny owns a life insurance policy that he no longer needs. Johnny exchanges the life insurance policy for an annuity. The exchange of policy will not cause recognition of gain since Johnny is exchanging a tax-free contract for an ordinary income contract. • When an insurance product that creates ordinary income is exchanged for an insurance product that would be tax free, there is immediate recognition of gain. • Example: Johnny owns an annuity contract. He has decided he does not need the annuity contract to provide retirement income and converts the annuity contract int o a life insurance contract. He paid $30,000 for the annuity contract that is now worth $100,000. Johnny cannot avoid the $70,000 realized gain when he surrenders the annuity to purchase the life insurance contract (a tax-free contract).