TD 10052 Resolves 1035 Exchange Life Insurance Trap

The problem TD 10052 fixes was never that Section 1035 exchanges suddenly looked abusive. It was stranger than that. The 2019 final regulations placed “the issuance of a policy in an exchange pursuant to section 1035” inside the definition of a transfer of an interest in a life insurance contract, even though the replacement policy received in a Section 1035 exchange is exchanged-basis property, not transferred-basis property.[1]

That single drafting choice mattered because the transfer-for-value rules under Section 101(a)(2) do not merely ask whether a policy moved from one contract to another. They ask whether the death benefit remains excludable from gross income after a transfer for valuable consideration, and one of the principal statutory escape routes is the transferred-basis exception. A Section 1035 replacement policy does carry tax basis from the old policy, but it does so as exchanged-basis property under Section 7701(a)(44), not as transferred-basis property. The old regulation therefore pushed ordinary exchanges toward a doorway that the statute did not open.

For an untainted retail policy, the defect might have stayed academic. For a policy that had already been through a reportable policy sale, or for life settlement funds and private placement life insurance structures holding acquired policies, the mismatch was not academic. If a later Section 1035 exchange itself counted as a transfer and the transferred-basis exception was unavailable, the new policy could inherit a partial death-benefit tax problem no one had deliberately created.[1]

That is why the new 1035 exchange life insurance regulations are more than a clean-up sentence. TD 10052, published in the Federal Register on July 9, 2026 and effective immediately, removes the mechanism that made the trap work and adds carryover rules so the tax character of the old contract does not become unknowable at the moment of exchange.[2]

The Fix Starts By Removing the False Transfer

The most important part of TD 10052 is also the cleanest: the final regulations delete the clause in Reg. § 1.101-1(e)(2) that had treated policy issuance in a Section 1035 exchange as a transfer for transfer-for-value and reportable-policy-sale purposes. The practical effect is that the mere issuance of the replacement contract is no longer the event that can trigger the transfer-for-value problem.[2]

The deletion does not pretend that prior history vanishes. A contract that was clean before the exchange does not need a new transfer-for-value analysis just because the policyholder moved into replacement coverage. A contract that was already limited by Section 101(a)(2) does not become clean merely because it was exchanged. TD 10052 solves the drafting mismatch without creating a purification rule.

The excludability carryover rule is the part practitioners will likely lean on first. Under new Reg. § 1.101-1(b)(2)(iv), full excludability carries over when the old policy was not tainted. If the old policy was subject to a Section 101(a)(2) limitation, the limitation carries into the new policy. Boot received in the exchange decreases excludability, while gain recognized increases it.[2]

The reportable-policy-sale carryover rule answers a related but distinct question. New Reg. § 1.101-1(c)(3) provides that when an RPS-tainted old policy is exchanged, the new policy is also treated as RPS-tainted. That is not a penalty for exchanging; it is continuity. The rule keeps a known status attached to the policy rather than forcing issuers and owners to reconstruct the tax effect of the exchange from the flawed transfer language that TD 10052 has now removed.[2]

Reporting Moved Away From the 2023 Proposal

The reporting change is where the final regulations become noticeably more administrable than the proposal. The 2023 proposed regulations would have expanded the definition of issuer to include Section 1035 issuers and would have required both old and new issuers to file Form 1099-SB information returns with the IRS. TD 10052 abandons that approach. The final rule instead uses a narrower carrier-to-carrier notice regime.[3]

Under Reg. § 1.6050Y-3(h), when an RPS-tainted contract is exchanged and the old and new issuers are different, the old issuer must notify the new issuer by any reasonable method. There is no Form 1099-SB filing under the abandoned proposed regime and no issuer-to-IRS filing under that approach.[2]

That is a real reduction in reporting burden, not just a change in form number. The IRS agreed with commenters that the burden of the proposed reporting regime outweighed its benefits, which explains why the final rule places the needed status information with the new issuer without building a broader IRS filing system around the exchange itself.[3]

The distinction matters operationally. A carrier receiving an RPS-tainted policy through a Section 1035 exchange still needs the status information because it may affect future reporting and death-benefit tax administration. But the final regulations do not ask every covered exchange to pass through the Form 1099-SB machinery the government first proposed.

The New Form 1099-R Code Is Still Only Anticipated

TD 10052 also points toward a Form 1099-R change, but this is not the same thing as having revised filing instructions in hand. The IRS has stated that it intends to revise Form 1099-R and its instructions to add a new Box 7 distribution code for RPS-tainted Section 1035 exchanges. The new code is expected to supplement, not replace, existing Code 6.[4]

Until the revised form and instructions are published, the safer reading is narrow: the final regulations have changed the substantive and issuer-notice rules, while the new Box 7 reporting code has not yet become an available current filing method. The missing code is not a reason to ignore RPS status, but it is a reason not to describe the Form 1099-R implementation as complete.

Retroactive Relief Is Available, Not Automatic

The retroactivity provision is the part most likely to separate a reassuring legal update from a useful compliance review. Reg. § 1.101-6(c) permits taxpayers to elect retroactive application of Reg. § 1.101-1(b)(2)(iv), Reg. § 1.101-1(c)(2)(v), and Reg. § 1.101-1(c)(3) to all exchanges and acquisitions after December 31, 2017. That window covers the period from the TCJA’s effective date through July 8, 2026.[5]

The election is not automatic. The available materials describe affirmative taxpayer action as required, with the precise procedure still unspecified. Practitioners may expect the election to appear through a return filing position or election statement, but the regulations do not provide a settled form or process, and further IRS procedural guidance may be needed.[5]

That leaves a practical file-room problem. Historical Section 1035 exchanges after December 31, 2017 should not be treated as self-correcting merely because TD 10052 fixed the regulation prospectively. Someone still has to identify the affected policies, determine whether any were RPS-tainted or otherwise subject to transfer-for-value limitations, decide whether the retroactive election is beneficial and available, and preserve the support for that decision.

• Review Section 1035 exchanges completed after December 31, 2017 and before July 9, 2026.
• Separate clean policies from policies with prior reportable-policy-sale or transfer-for-value history.
• Identify exchanges involving different issuers, because the final rule uses issuer-to-issuer notice for RPS-tainted contracts.
• Track transactions that may require a retroactive election once the IRS specifies the procedure.
• Avoid treating the anticipated Form 1099-R Box 7 code as available until revised forms and instructions are issued.

These are compliance considerations, not a universal prescription. The right response will depend on ownership history, issuer records, prior reporting positions, and the taxpayer’s broader return posture. What TD 10052 does make clear is that the correction can reach back; it does not make the act of reaching back automatic.

COLI Relief Remains Narrow

TD 10052 also finalizes a de minimis exception for certain corporate-owned life insurance acquisitions, but the boundary is tight. Reg. § 1.101-1(c)(2)(v) is limited to direct acquisitions of life insurance interests from one C corporation by another C corporation in a Section 368(a) reorganization where no more than 5% of gross assets consists of life insurance, the target conducts an active trade or business, and neither party engages in a life insurance investment business.[6]

The IRS adopted the proposed de minimis exception without change despite requests to expand relief to taxable transactions, S corporations, partnerships, and affiliated-group testing. The preamble says the IRS will continue to study a broader rule.[6]

Two details deserve attention before anyone treats the exception as a general corporate-transaction safe harbor. The 5% test is based on gross value of assets, not net assets or book value. And the active-trade-or-business requirement may be awkward for holding-company structures, particularly where COLI is held above the operating business. The final rule is useful for the fact pattern it covers; it is not broad relief for every corporate acquisition involving policies.

What Is Settled, and What Still Needs Administration

The settled point is substantial. Policy issuance in a Section 1035 exchange is no longer treated as the transfer that created the 1035 exchange trap. Excludability and RPS status now carry over under express rules rather than through an ill-fitting transferred-basis theory. The proposed Form 1099-SB regime is gone, replaced by old-issuer notice to the new issuer when an RPS-tainted contract moves between different carriers.

The unfinished work is also concrete. Historical exchanges after December 31, 2017 need review for possible retroactive election treatment. RPS-tainted exchanges need issuer-status information to move with the policy. Form 1099-R implementation is waiting on a new Box 7 code and revised instructions. COLI structures need to be tested against a narrow C-corporation reorganization exception, not against the broader relief commenters requested.

TD 10052 removes the regulatory defect. It does not remove the need to document which contracts were affected, which notices must be sent, which elections should be made, and which reporting details are still missing.

References

1. IRS Fixes the 1035 Exchange Trap, Katten
2. Information Reporting and Transfer for Valuable Consideration Rules for Section 1035 Exchanges of Life Insurance Contracts, Federal Register, July 9, 2026
3. Final IRS Rules on Information Reporting and Transfer for Value Rules Involving Section 1035 Exchanges, Groom Law Group
4. US Treasury Releases Life Insurance Reportable Policy Sale Final Regulations, Faegre Drinker
5. Treasury and IRS Finalize Reporting Rules for Section 1035 Exchanges and Transfers of Life Insurance Contracts, Liskow & Lewis
6. Final regulations confirm treatment of life insurance policy exchanges, PwC