August 6, 2026
4:30 pm

Finding the Cost Basis in Your Policy

Call the carrier and ask, in writing, for your “investment in the contract” — that is the term the service department will recognize, and it is the number the IRS uses. Ask for it as of a specific date and ask for the total gross premiums paid since issue separately, because those two figures can differ and the difference is usually where the story is. Do this before you accept any offer, surrender anything, or let a loaned policy lapse. It is a five-minute request that routinely changes a five-figure tax outcome.

Cost basis in a life insurance policy is, as a general rule, the total premiums you have paid, reduced by amounts you have already received tax-free — cash dividends taken in cash, prior withdrawals or partial surrenders, and certain rider charges. It is not the cash surrender value, it is not the death benefit, and it is not what you “have in” the policy according to the annual statement’s accumulation column.

One change in the law reshaped this entire topic and many people, including some advisors, have not caught up. For roughly eight years the IRS took the position that a seller had to reduce basis by the cost of insurance charges the policy had absorbed. Congress reversed that. If you are working from advice given before 2018, the number you were told is probably too low.

In This Article

The Rule That Changed, and Why It Matters to You
What Goes Into the Number
How Basis Determines What You Actually Owe
Getting the Number Out of the Carrier
What Forms 1099-LS and 1099-SB Do
Where Basis Changes the Decision Among Your Options
When the Basis Answer Says Do Not Sell
Frequently Asked Questions

The Rule That Changed, and Why It Matters to You

In 2009 the IRS issued Revenue Ruling 2009-13, which addressed how a policy owner computes gain on the surrender or sale of a life insurance policy. In the sale scenario it required the seller to reduce basis by the cost of insurance charges the policy had incurred — on the theory that the owner had consumed insurance protection and should not also get basis credit for paying for it. The practical effect was to inflate taxable gain, and on older policies with decades of mortality charges the effect was large.

Section 13521 of the Tax Cuts and Jobs Act of 2017 repealed that adjustment. Basis is no longer reduced by cost of insurance charges, and the change applies retroactively to transactions entered into after August 25, 2009 — the date of the original ruling. The companion Revenue Ruling 2009-14, which addressed the buyer’s side, was left in place.

Two groups gained the most. Term policy sellers, whose entire premium is effectively cost of insurance and whose basis under the old rule could round to nearly zero, now get credit for premiums paid. And long-held universal life owners, whose accumulated mortality charges over thirty years can run into six figures, recover a meaningful basis number. If someone quoted you a taxable gain figure computed by subtracting cost of insurance from basis, ask them to rerun it. See how the 2017 tax law changed settlement taxation.

What Goes Into the Number

Adds to basis: every gross premium you paid, including premiums paid by automatic bank draft, premiums paid by a third party on your behalf if you were the owner, and premiums paid from dividends applied to reduce premium. If you acquired the policy in a Internal Revenue Code section 1035 exchange, the basis from the old contract carries over into the new one — this is the single most commonly missed adjustment, because the new carrier’s records start at zero. If you received the policy by gift, basis generally carries over from the donor under section 1015. If you received it from a spouse incident to divorce, basis carries over under section 1041.

Subtracts from basis: dividends you took in cash or that were paid to you; withdrawals and partial surrenders that were treated as a return of investment; and, under Internal Revenue Code section 72(e)(11), charges deducted from cash value to pay for qualified long-term care coverage on a rider, which reduce your investment in the contract without being taxable to you when charged.

Does not change basis: a policy loan. Borrowing is not a distribution and does not reduce basis. This matters enormously in the lapse scenario, because a policy with a large loan can lapse and produce taxable income even though you never received a check — see how modified endowment contract rules complicate distributions and basis in a settlement.

Also does not change basis: the growth in cash value itself. Inside buildup is not taxed as it accrues and it is not basis.

How Basis Determines What You Actually Owe

The framework for a sale, drawn from Revenue Ruling 2009-13, splits your proceeds into three layers.

Layer one: proceeds up to your cost basis are a tax-free return of capital.

Layer two: proceeds above basis, up to the policy’s cash surrender value, are ordinary income. This layer represents inside buildup you would have been taxed on had you simply surrendered.

Layer three: proceeds above the cash surrender value are capital gain, long-term if you held the policy more than a year. This is the layer that exists only because you sold rather than surrendered.

Surrender is different and simpler, and worse. On a surrender, everything above basis is ordinary income. There is no capital gain layer at all, because there is no sale price above surrender value. That structural difference is why the same policy can produce a materially better after-tax result through a sale than through a surrender, even before considering that the gross sale price is usually higher. Compare the two on settlement versus cash surrender value.

Term policies simplify further. With no cash surrender value, there is no ordinary income layer: proceeds above basis are capital gain. Viatical settlements are different again — where the insured is certified terminally or chronically ill and the provider meets the requirements of Internal Revenue Code section 101(g)(2), the proceeds are generally excluded from income entirely.

Item	Effect on cost basis	Notes
Gross premiums paid	Increases	Includes premiums paid by dividends applied to premium
Dividends taken in cash	Decreases	Generally tax-free until cumulative dividends exceed basis
Withdrawals / partial surrenders	Decreases	To the extent treated as return of investment
Qualified LTC rider charges	Decreases	IRC 72(e)(11); not taxable when charged
Cost of insurance charges	No effect	TCJA 2017 repealed the Rev. Rul. 2009-13 reduction
Policy loans	No effect	Borrowing is not a distribution
Inside cash value growth	No effect	Not taxed as it accrues; not basis
1035 exchange	Carries over	Confirm the new carrier recorded it

How Basis Determines What You Actually Owe

Getting the Number Out of the Carrier

Carriers do not print basis on the annual statement, and front-line service representatives often do not know the term. Ask for one of these, in this order: “investment in the contract as of [date]”; “total gross premiums paid since issue”; “cost basis for tax purposes.” Request it in writing through the carrier’s secure message system so you have a dated record.

Expect friction on older policies. Carriers that acquired blocks through mergers or demutualizations sometimes cannot reconstruct premium history before the conversion date. If the carrier cannot produce it, your own records become the evidence: cancelled checks, bank statements showing the draft, old premium notices, prior tax returns. Reconstructing forty years of $180 quarterly drafts is tedious but it is worth real money.

Also request an in-force illustration and the current cash surrender value at the same time. Basis alone tells you nothing; basis compared to surrender value tells you where the ordinary income layer ends and the capital gain layer begins.

Common trap: if the current policy came from a 1035 exchange, ask the current carrier whether it was given the carryover basis from the prior contract. Frequently it was not, and the number it reports will be wrong in your disfavor. Track down the old carrier.

What Forms 1099-LS and 1099-SB Do

The Tax Cuts and Jobs Act added Internal Revenue Code section 6050Y, which created an information reporting regime around “reportable policy sales.” Final regulations were issued in 2019, and the reporting applies to sales after December 31, 2018.

Two forms concern a seller. Form 1099-LS is filed by the acquirer reporting the payment made to you for the policy. Form 1099-SB is filed by the issuer — your insurance carrier — reporting your investment in the contract and the policy’s surrender value. In other words, the carrier tells the IRS what your basis is, whether or not it told you first.

That is a strong practical argument for pulling the number yourself before you sign anything. If the carrier’s figure is wrong — most often because a 1035 carryover basis was not recorded — you want to be arguing about it before it lands on a return, not after. Read what to expect on your 1099 after a settlement and how settlement proceeds are taxed.

None of this is tax advice, and the arithmetic depends on facts specific to you. Have your own CPA run the numbers before you commit — a CPA review before selling typically costs a few hundred dollars and routinely finds more than that.

Where Basis Changes the Decision Among Your Options

Keep the policy. Basis is irrelevant if you never dispose of it, because a death benefit paid to a beneficiary is generally excluded from income under Internal Revenue Code section 101(a). That exclusion is the reason “keep it” is so often the highest after-tax answer.

Surrender. Everything above basis is ordinary income. If basis is high relative to surrender value, surrender may be nearly tax-free — and if basis exceeds surrender value, the loss is generally not deductible for a personal policy.

Reduced paid-up or extended term. Electing a nonforfeiture option is not a taxable disposition. Premiums stop, coverage continues in reduced form, and basis rides along. Frequently the best answer for someone who cannot pay but does not want a tax event.

1035 exchange. No current tax, basis carries over. Make sure the receiving carrier records it.

Accelerated death benefit. Qualifying payments to a terminally or chronically ill insured are generally excluded from income under section 101(g), which is why the rider often beats every alternative on an after-tax basis. Chronic illness payments are subject to a per-diem limitation tied to section 7702B.

Sell the policy. Three-layer treatment as above, and generally the highest gross number for an older or health-impaired insured with roughly $100,000 or more of death benefit.

When the Basis Answer Says Do Not Sell

Basis analysis kills some deals, and it should. If a projected offer is only marginally above cash surrender value, the entire excess is ordinary income territory below surrender value and the after-tax improvement over simply surrendering may be trivial — while the sale costs you months and a stack of medical records. Run both after-tax numbers before you decide.

If the policy is a modified endowment contract, the ordering rules under section 72(e)(10) treat distributions as income first, and a pre-59½ owner can face an additional 10% penalty on the taxable portion. That changes the arithmetic on loans and withdrawals, though not on a sale.

And if the insured is terminally or chronically ill, look hard at the accelerated death benefit rider and at the viatical exclusion under section 101(g) before pursuing a taxable sale. Getting the money tax-free from the carrier usually beats getting a somewhat larger number from a buyer and paying tax on it. Our page on whether settlement proceeds are taxable lays out the comparison.

For a free, no-obligation review of what your policy is worth and where the tax layers fall, send the policy cover page or call (305) 209-7183. Pine Lake Life Solutions provides education and policy reviews only and does not give tax or legal advice; your CPA should compute your actual liability.

Frequently Asked Questions

Is my cost basis the same as my cash surrender value?

No, and confusing the two is the most common error here. Basis is generally what you paid in, reduced by tax-free amounts already received. Surrender value is what the carrier will hand you today. Either can be larger. The gap between them defines the ordinary income layer if you sell or surrender.

Do cost of insurance charges still reduce basis?

No. Revenue Ruling 2009-13 originally required that reduction, but section 13521 of the Tax Cuts and Jobs Act of 2017 repealed it for transactions after August 25, 2009. If an advisor computed your gain by subtracting decades of mortality charges from your premiums, that figure predates the change and should be rerun.

How do I get the number if my carrier cannot produce it?

Reconstruct it from your own records: cancelled checks, bank statements showing the premium draft, old premium notices, and prior returns. This happens often on policies that moved through a merger or demutualization. Keep the workpapers, because if the carrier files a Form 1099-SB with a different figure you will need to explain the difference.

What happens to basis in a 1035 exchange?

It carries over to the new contract, which is the point of the exchange. The practical risk is administrative: receiving carriers sometimes fail to record the carryover figure and start the contract at zero basis. Ask the new carrier in writing what investment in the contract it has on file, and correct it early if it is wrong.

Does a policy loan reduce my basis?

No. A loan is borrowing, not a distribution, so basis is unaffected. The danger is on the back end: if a heavily loaned policy lapses or is surrendered, the loan is treated as an amount received, which can produce taxable income far exceeding any cash you actually get. That is a genuine trap worth planning around.

Who reports my basis to the IRS?

Your insurance carrier does, on Form 1099-SB, under the reporting regime added by Internal Revenue Code section 6050Y for reportable policy sales after 2018. The buyer separately files Form 1099-LS reporting what it paid you. Pull your basis figure from the carrier before signing so you are not surprised by what gets filed.

If my basis exceeds what I get, can I deduct the loss?

For a personal life insurance policy, generally no. The IRS has long treated the excess of premiums over surrender value as a nondeductible personal expense rather than a capital loss. Business-owned contracts can be analyzed differently. This is exactly the kind of question to put to your own CPA rather than resolve from a web page.

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