Selling a Life Insurance Policy: Tax, Basis and Form 1099-LS
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Quick Answer
Surrendering a life insurance policy taxes only the cash you receive above the premiums you paid, all as ordinary income; selling it (a life settlement) taxes the price above the premiums you paid, with the same slice as ordinary income and anything above that as long-term capital gain. As of October 23, 2026: since the 2017 tax act added Section 1016(a)(1)(B), the cost of insurance no longer reduces your basis, so Rev. Rul. 2020-05 puts the gain on the IRS's $80,000 example sale at $16,000 ($14,000 ordinary, $2,000 capital), not the $26,000 the 2009 ruling gave. A term policy sold for $20,000 after $45,000 of premiums is now a $25,000 capital loss, not a $19,750 gain, and the loss is not deductible unless it is a trade-or-business or for-profit loss under Section 165(c)(1) or (2). The buyer reports the price on Form 1099-LS; your insurer reports your investment in the contract and the surrender amount on Form 1099-SB, and the gap between those two boxes is your ordinary income. Read from IRS rulings, instructions and the U.S. Code on October 23, 2026.
Key Takeaways
- Surrender is taxed under Section 72(e)(5)(A): the amount received is income only “to the extent it exceeds investment in the contract”, meaning premiums paid less amounts received earlier that were not taxed. Rev. Rul. 2009-13 Situation 1 has $64,000 of premiums and $78,000 paid on surrender, so $14,000 of income, all ordinary. Nothing in that ruling treats a surrender as capital gain.
- A sale is taxed as sale price minus adjusted basis. Since Pub. L. 115-97 section 13521(a) (December 22, 2017) added Section 1016(a)(1)(B), basis is not reduced for “mortality, expense, or other reasonable charges”. Rev. Rul. 2020-05 applies it to every transaction entered into on or after August 26, 2009, and says basis in the IRS example “equals the premiums paid”.
- The ordinary slice of a sale is capped at what a surrender would have produced. Rev. Rul. 2009-13 limits the “substitute for ordinary income” doctrine to the inside build-up, cash surrender value minus premiums ($14,000 in its example). The rest of the gain is long-term capital gain if you held the policy more than a year. Rev. Rul. 2020-05 footnote 1 says the 2017 act does not change character.
- The amendment helps sellers. On the IRS example the taxable gain falls from $26,000 to $16,000, all of the $10,000 cut coming out of the capital part ($12,000 to $2,000). On our whole life example with $90,000 of cost-of-insurance charges, the old rule would have taxed $90,000 more as capital gain, about $18,000 of federal tax at 20% (our arithmetic). Broker and advisor pages that still quote the $26,000 figure are using the superseded numbers.
- A loss is not a deduction. In Rev. Rul. 2009-13 Situation 3 (a term policy, $45,000 of premiums, sold for $20,000) the 2009 ruling gave a $19,750 gain; Rev. Rul. 2020-05 gives a $25,000 long-term capital loss that “will not be permitted” as a deduction unless incurred under Section 165(c)(1) or (2). A surrender with cash value below premiums produces no income and no stated loss either.
- Two Forms feed your return. The acquirer files Form 1099-LS with the amount paid to you (Box 1) and the date of sale (Box 2); the insurer files Form 1099-SB with your investment in the contract (Box 1) and the surrender amount (Box 2). A surrender comes on Form 1099-R, usually with code 7. A broker that keeps part of the price can be a payment recipient too, if it receives $600 or more.
- Illness changes everything. Under Section 101(g), a sale of part of the death benefit to a licensed viatical settlement provider by a terminally ill insured (death reasonably expected within 24 months of a physician’s certification) is treated as paid by reason of death, so it is excluded. For a chronically ill insured the excluded per diem benefit is capped at $430 a day for 2026 (Rev. Proc. 2025-32 section 4.62); $420 in 2025.
- What is new in 2026 is T.D. 10052 (effective July 9, 2026), final regulations that stop a Section 1035 exchange of a policy bought in a reportable policy sale from being reported under Treas. Reg. 1.6050Y-2. It governs buyers and their later exchanges, not the tax on your sale. The 2025 law (Pub. L. 119-21) amended only Section 1016(a)(14) among the sections we read, not (a)(1)(B).
CSV · 98 rows
Selling a life insurance policy: IRS rulings, statute text, Forms 1099-LS and 1099-SB, and three sample policies
98 rows: the worked facts and holdings of Rev. Rul. 2009-13 and 2020-05, the text of Sections 1016(a)(1)(B), 72(e), 101(a)(2), 101(a)(3), 101(g) and 6050Y, the Form 1099-LS, 1099-SB and 1099-R instructions, Treas. Reg. 1.6050Y-2 deadlines, IRS Publication 525 (2025), the 2026 capital gains rate amounts and the per diem, T.D. 10052, and our arithmetic on a whole life policy, a term policy and a policy with cash value below premiums. Source and source ID on every row.
Surrender, sale and illness: three different taxes
A life insurance policy that no longer fits can be kept, let lapse, surrendered to the insurer, sold to a buyer in a life settlement, or, if the insured is seriously ill, sold or drawn on under Section 101(g). Each has its own tax. The table puts them side by side, using the text of the rulings and the code.
| Question | Surrender to the insurer | Sell to a buyer (life settlement) | Insured terminally or chronically ill |
|---|---|---|---|
| What is taxed | Proceeds above investment in the contract (Section 72(e)(5)(A)); Rev. Rul. 2009-13 Situation 1: $78,000 paid, $64,000 of premiums, $14,000 of income | Sale price minus adjusted basis (Section 1001; Rev. Rul. 2009-13 Situation 2 and Rev. Rul. 2020-05) | Nothing, for amounts treated as paid by reason of death (Section 101(g)(1)); a sale of part of the death benefit to a licensed viatical settlement provider is treated the same way (Section 101(g)(2)(A)) |
| Basis or cost | Premiums or other consideration paid, less amounts received earlier that were excludable (Section 72(e)(6)) | Premiums paid; not reduced by the cost of insurance (Section 1016(a)(1)(B); Rev. Rul. 2020-05) | Not needed if the exclusion applies in full |
| Character of the income | Ordinary | Ordinary up to the inside build-up (cash surrender value minus premiums); the excess is long-term capital gain if the policy was held more than one year (Rev. Rul. 2009-13) | Excluded; for a chronically ill insured, per diem payments above the $430 a day limit for 2026 are not excluded (Rev. Proc. 2025-32 section 4.62) |
| Form from the other side | Form 1099-R from the insurer; Publication 525 says to expect the total proceeds and the taxable part, and the instructions say generally code 7 | Form 1099-LS from the acquirer; Form 1099-SB from the insurer | Check which forms the provider and insurer issue; the 1099-LS rules apply to reportable policy sales |
| If the amount received is below what you paid | No income; Section 72(e)(5)(A) taxes only the excess | A long-term capital loss on the sale, deductible only if Section 165(c)(1) or (2) applies (Rev. Rul. 2020-05 Situation 3) | Not applicable |
| Who is the other party | The insurer that issued the contract | A buyer with no substantial family, business or financial relationship with the insured, which is what makes the sale a reportable policy sale (Section 101(a)(3)(B)) | A viatical settlement provider licensed in the insured’s State or meeting the model act and regulation requirements of Section 101(g)(2)(B) |
Source: Rev. Rul. 2009-13; Rev. Rul. 2020-05; 26 U.S. Code Sections 72, 101, 1016 and 6050Y; IRS Publication 525 (2025); Instructions for Forms 1099-R and 5498 (2026); Rev. Proc. 2025-32, read on October 23, 2026.
A lapse (stopping premiums with no cash value left) is not addressed by any of the documents we read. It produces no proceeds, so no amount is received to tax, but whether any policy loan that is wiped out on lapse is income is a question for the insurer’s Form 1099-R and your preparer. Publication 525 defines your cost as premiums paid less “refunded premiums, rebates, dividends, or unrepaid loans that weren’t included in your income”.
The basis change nobody quotes: $26,000 became $16,000
Most pages that explain life settlement tax, and most broker pages, still give the 2009 numbers. Rev. Rul. 2009-13 said a seller who kept a policy for insurance protection had to reduce basis by the cost of insurance before computing gain on a sale. Then Pub. L. 115-97 section 13521(a), signed December 22, 2017, added Section 1016(a)(1)(B), which bars any basis adjustment “for mortality, expense, or other reasonable charges incurred under an annuity or life insurance contract”. Section 13521(b) applies it to transactions entered into after August 25, 2009. In Rev. Rul. 2020-05 the IRS says the 2009 holdings are “inconsistent with the language of § 1016(a)(1)(B)” and modifies them.
The ruling’s own sentence is short: “Under § 1016(a)(1)(B), the cost basis of a life insurance contract is not reduced by the cost of insurance, regardless of why the contract is purchased.” Here is what it does to each of the IRS’s facts.
| IRS facts | Premiums paid | Amount received | 2009 rule (Rev. Rul. 2009-13) | Current rule (Rev. Rul. 2020-05) |
|---|---|---|---|---|
| Situation 1: surrender of a cash value policy | $64,000 | $78,000 cash surrender value | $14,000 ordinary income | Unchanged: $14,000 ordinary income |
| Situation 2: sale of the same policy to an unrelated buyer | $64,000 | $80,000 sale price | Basis $54,000; $26,000 gain: $14,000 ordinary, $12,000 long-term capital gain | Basis $64,000; $16,000 gain: $14,000 ordinary, $2,000 long-term capital gain |
| Situation 3: sale of a level premium 15-year term policy with no cash value | $45,000 | $20,000 sale price | Basis $250; $19,750 long-term capital gain | Basis $45,000; $25,000 long-term capital loss, not deductible unless Section 165(c)(1) or (2) |
| Rev. Rul. 2009-14 Situation 2: a profit buyer resells a term policy | $20,000 purchase price plus $9,000 of premiums | $30,000 resale price | $1,000 long-term capital gain | Unchanged: $1,000 long-term capital gain |
Source: Rev. Rul. 2009-13 (Situations 1 to 3), Rev. Rul. 2009-14 (Situation 2) as modified by Rev. Rul. 2020-05, read on October 23, 2026.
Two details matter. First, the ordinary slice did not move: it is still the $14,000 a surrender would have produced, because Rev. Rul. 2020-05 footnote 1 says Section 13521 “does not affect the analysis” of character. Only the capital part shrank. Second, the ruling closes with a warning for anyone thinking of amending old returns: Congress did not extend the Section 6511 limitation period, so a refund claim for a year that is already time-barred is still barred.
Three sample policies: surrender, sale and the old rule
The IRS uses small numbers. A reader with a $500,000 policy needs the same arithmetic at scale. The three policies below are invented; the method is the rulings’.
| Policy (invented) | Surrender: income and tax | Sale, current rule: income and tax | Sale, 2009 rule (superseded) | What differs |
|---|---|---|---|---|
| A: whole life; premiums $400,000; cash surrender value $520,000; buyer offers $650,000; cost-of-insurance charges $90,000 | $120,000 ordinary; $44,400 federal tax at 37%; $475,600 left | Gain $250,000: $120,000 ordinary, $130,000 long-term; $70,400 tax at 37% and 20%; $579,600 left | Gain $340,000: $120,000 ordinary, $220,000 long-term; $88,400 tax | The 2017 change removes $90,000 of capital gain, $18,000 of tax at 20% |
| B: term; premiums $45,000; sold for $20,000 (the IRS facts) | Not available: no cash surrender value | $25,000 long-term capital loss; not deductible unless Section 165(c)(1) or (2) | $19,750 long-term capital gain | A taxable gain became a loss that usually cannot be used |
| C: whole life; premiums $400,000; cash surrender value $380,000; buyer offers $450,000 | No income: proceeds do not exceed investment in the contract | Gain $50,000, no ordinary slice because there is no inside build-up; all long-term capital gain; $10,000 tax at 20% | Gain $140,000 long-term capital gain; $28,000 tax at 20% | A buyer pays $70,000 more than the surrender value, and it is all capital gain |
Source: our arithmetic on invented amounts, using Rev. Rul. 2009-13 and 2020-05 (ordinary slice = cash surrender value minus premiums; basis = premiums paid) and an illustrative 37% ordinary and 20% long-term rate. It ignores state tax, the net investment income tax, commissions, surrender charges, policy loans and prior withdrawals. The 20% rate applies only above $545,500 (single) or $613,700 (married filing jointly) of taxable income for 2026 (Rev. Proc. 2025-32 section 4.03); below those amounts the long-term rate is 15% or 0%.
The arithmetic in policy A shows why the choice is about more than the headline offer. Before tax, the sale pays $130,000 more than the surrender ($650,000 against $520,000); after the illustrative federal tax it pays $104,000 more ($579,600 against $475,600), because the extra $130,000 of gain is taxed at the lower rate ($26,000 of tax). The offer in the example is invented. No document we read gives a typical price, and a real offer depends on the insured’s health, the premiums still due and the death benefit. In policy C, the sale’s 20% tax is on a $50,000 gain that exists only because a buyer pays more than the insurer; in a surrender there would be no tax and no deduction.
Which Form tells you what
Selling a policy produces two new Forms that surrendering never did. Section 6050Y(a) makes the acquirer in a reportable policy sale file a return; Section 6050Y(b) makes the insurer report the seller’s investment in the contract. Together they hand your preparer the two numbers the rulings need.
| Form | Who sends it | What it shows | What you do with it |
|---|---|---|---|
| Form 1099-LS, Reportable Life Insurance Sale | The acquirer (buyer) | Box 1: amount paid to the payment recipient; Box 2: date of sale; also the issuer and the policy number | Box 1 is the amount realized for your gain; the filing deadline is February 28 (March 31 if filed electronically) of the year after the sale and the statement to you is due February 15 (Treas. Reg. 1.6050Y-2) |
| Form 1099-SB, Seller’s Investment in Life Insurance Contract | The insurer (issuer) | Box 1: investment in contract; Box 2: surrender amount, meaning what you would have received on a surrender on the date of the sale | Box 2 minus Box 1 is your ordinary income if positive (our arithmetic from Rev. Rul. 2009-13); Box 1 is also the insurer’s figure for your premiums |
| Form 1099-R | The insurer, on a surrender | Total proceeds and the taxable part; the instructions say to use code 7 for a life insurance distribution if no other code applies | Lines 5a and 5b of Form 1040 (Publication 525) |
Source: Instructions for Forms 1099-LS and 1099-SB (Rev. April 2025); Instructions for Forms 1099-R and 5498 (2026); Treas. Reg. 1.6050Y-2; IRS Publication 525 (2025), read on October 23, 2026.
For the code on a surrender, our Form 1099-R box 7 codes page lists them. A practical use of the two numbers: the insurer’s Box 2 on Form 1099-SB is the surrender value on the sale date and its Box 1 is premiums less tax-free amounts you received, so the pair gives the ordinary slice without a calculation. Check that Box 1 matches your own premium records. For a seller who is not the original policyholder, the instructions limit the insurer to “the information that is known to the issuer”, so the figure can be incomplete. If a broker keeps part of the price, the instructions say it can also be a payment recipient, but only if it receives $600 or more; whether commissions reduce your amount realized is a question we found no document answering, so ask your preparer.
If a sale is rescinded after a Form 1099-LS is filed, the acquirer has 15 calendar days after notice to file a corrected form.
Illness: when a sale can be tax-free
Section 101(g)(1) treats “any amount received under a life insurance contract” on the life of a terminally or chronically ill insured as paid by reason of the insured’s death, which makes it excludable. Section 101(g)(2)(A) extends that to a sale of part of the death benefit to a viatical settlement provider. The definitions are in the table.
| Insured is | Definition used | Excluded amount | Source |
|---|---|---|---|
| Terminally ill | A physician has certified an illness expected to result in death within 24 months of the certification | Accelerated death benefits and sales to a viatical settlement provider are excluded in full | Section 101(g)(4)(A); Publication 525 (2025) |
| Chronically ill, not terminally ill | Section 101(g)(4)(B), which uses Section 7702B(c)(2) | Benefits for costs incurred for qualified long-term care services are excluded; per diem or periodic benefits only up to $430 a day for 2026 ($420 for 2025) | Publication 525 (2025); Rev. Proc. 2025-32 section 4.62 |
| Neither | Not ill under Section 101(g)(4) | No exclusion; use the surrender and sale rules above (Rev. Rul. 2009-13 Situation 1 states the seller was neither terminally nor chronically ill) | Rev. Rul. 2009-13 |
Source: 26 U.S. Code Section 101(g); IRS Publication 525 (2025); Rev. Proc. 2025-32, read on October 23, 2026. The per diem limit is the same $430 that applies to long-term care insurance; our long-term care tax page covers it.
The provider has to meet the statute. Section 101(g)(2)(B) defines a viatical settlement provider as a person regularly engaged in buying policies on the lives of terminally or chronically ill insureds who is licensed in the insured’s State or, where the State does not license, meets the model act and regulation tests. Section 101(g)(5) also carves out amounts paid to a taxpayer other than the insured who has an insurable interest because the insured is a director, officer or employee. Selling to anyone else is a plain sale under the sale rules above. Our page on long-term care insurance tax and the per diem limit covers the same $430 figure from the care side.
The buyer’s tax, and why it affects your price
A buyer who pays for a policy wants the death benefit tax-free when the insured dies. Section 101(a)(2) says that after a transfer for valuable consideration, the excluded death benefit cannot exceed “the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee”, with exceptions for carryover-basis transfers and transfers to the insured, a partner of the insured, a partnership in which the insured is a partner, or a corporation in which the insured is a shareholder or officer. Section 101(a)(3) removes the limit for a “reportable policy sale”, which is an acquisition by someone who “has no substantial family, business, or financial relationship with the insured” apart from the interest in the contract.
For you, as the seller, that rule is why a stranger can pay for the contract and still keep the death benefit tax-free, and why the buyer files Form 1099-LS. A sale to someone with a substantial family, business or financial relationship with the insured is not a reportable policy sale by that definition, and the exceptions in Section 101(a)(2) decide its treatment instead; ask a preparer before structuring one. Our page on irrevocable life insurance trusts covers holding a policy in a trust, and the estate tax exemption page covers whether the death benefit is in a taxable estate in the first place.
What changed in 2026, and what did not
T.D. 10052, published in the Federal Register on July 9, 2026 (91 FR 42353) and in Internal Revenue Bulletin 2026-31, amends Treas. Reg. 1.101-1, 1.101-6 and 1.6050Y-1 through 1.6050Y-4, effective July 9, 2026. The preamble says that, because Section 1035 exchanges of policies bought in a reportable policy sale “would no longer be required to be reported under § 1.6050Y-2”, the reporting of reportable death benefits moves to the rules for contracts issued in those exchanges. It is a buyer-side change. The Instructions for Form 1099-LS (Rev. April 2025) already list a Section 1035 acquisition as a possible exception. Our 1035 exchange page covers the exchange rules.
The 2025 law, Pub. L. 119-21, is in the amendment notes of Cornell LII’s text of Section 1016, but only for subsection (a)(14), not subsection (a)(1)(B). The notes on Sections 101, 72 and 6050Y that we read list nothing after Pub. L. 115-97. We found no 2027 inflation revenue procedure yet; the $430 per diem and the capital gain rate amounts above are the 2026 figures.
What a reader can do with this
- Get the numbers before you get an offer. Ask the insurer for an in-force illustration and the current cash surrender value, and your premium history. Those give the investment in the contract and the inside build-up that the rulings use.
- Compute the ordinary slice first. Cash surrender value minus premiums paid (less any tax-free amounts received) is the ordinary income in both a surrender and a sale. A sale only adds a capital gain, or a capital loss, above that.
- Ask whether any outstanding policy loan, withdrawal or dividend changes the investment in the contract. Publication 525 subtracts amounts received that were not taxed; each of them can change the figure the insurer reports in Box 1 of Form 1099-SB.
- Use the 2020 ruling, not the 2009 one, when comparing offers. If a settlement firm’s illustration subtracts the cost of insurance from basis, it is using a superseded rule; ask which ruling it follows.
- Ask who reports. Request the buyer’s Form 1099-LS procedure and the expected February statement date, and ask the insurer to confirm it will issue Form 1099-SB.
- If anyone in the family is seriously ill, ask first about Section 101(g). A physician’s certification may turn a taxable sale into an excluded one.
- Compare with keeping it. An irrevocable life insurance trust, a Section 1035 exchange into a long-term care contract, or an exchange to a smaller policy avoid a taxable event altogether; each has its own rules on the pages linked above.
- Take the three questions to a preparer before you sign: is my basis premiums paid with no cost-of-insurance reduction, what does the 1099-SB show, and what will the sale do to this year’s bracket?
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FAQ
Sources, read and saved on October 23, 2026: Rev. Rul. 2009-13 and Rev. Rul. 2009-14 (IRS); Rev. Rul. 2020-05 (IRS); 26 U.S. Code Sections 72, 101, 1016, 1035 and 6050Y and 26 CFR 1.6050Y-2 (Cornell Legal Information Institute); Instructions for Form 1099-LS and Form 1099-SB (Rev. April 2025); Instructions for Forms 1099-R and 5498 (2026); IRS Publication 525 (2025); Rev. Proc. 2025-32; T.D. 10052 in Internal Revenue Bulletin 2026-31. The three sample policies, the tax figures and the percentages are our arithmetic on invented numbers. This is analysis of public documents, not investment, legal or tax advice.
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