Is the loss from a fixed/variable annuity tax deductible?

by Jeffrey S. Berdahl, CPA | Oct 06, 2014
askacpaiconMy husband and I bought into a fixed/variable annuity several years ago ($65,000). The value kept decreasing over the years and so this year we decided to close the account. Our loss was about $26,000. Is this loss tax deductible?

First, you have to sell or surrender the contract. You may not exchange the annuity contract for another product under Section 1035. To calculate your gain or loss, you have to figure out your cost basis. This is the amount you paid for the contract minus any withdrawal you have made.  From this, you subtract the proceeds from the sale.  If you pay a surrender charge, you must add this back to the proceeds.

For example, if we assume you purchased a variable annuity for $100,000, and you did not make any withdrawal, you have to pay a surrender charge of $5,000 and the annuity is worth $80,000 on the day that you cash it in.

Even though you receive a check for $75,000, your loss is $20,000. The $5,000 is not considered part of your loss.  Also, if you are under the age of 59 1/2, there will be no 10 percent early withdraw penalty, because it is only imposed on gains.

The unsettled issue is where to report the loss on your income tax return. A loss on a variable annuity is not considered an investment loss to be shown on schedule D with other capital gains and losses. It is classified as an ordinary loss.

The conservative approach is to treat the loss on the surrender of your annuity contract as a miscellaneous deduction on schedule A, Form 1040. You will only get a deduction to the extent your total miscellaneous itemized deductions exceed two percent of your adjusted gross income.

However, a position can be taken to deduct the loss on line 14, form 1040, Other Gains/Losses.  Revenue Ruling 61-201, 1961-2 CB 48 supports treating the loss as an ordinary loss. In this case, you could deduct the full loss without being subject to the two percent limit.

In closing, this is an unsettled area with the tax code and taking this loss as ordinary might be disallowed on audit. However, the Revenue Ruling provides substantial authority to take the loss.
The information provided here is of general nature and is not intended to address the unique fact pattern of any individual or entity. In specific circumstances, the services of a professional should be sought.

Answer By: Jeffrey S. Berdahl, CPA, is a shareholder with Regan Levin Bloss Brown & Savchak PC in Allentown. 
The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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