How Do You Report a 1035 Exchange on Form 1099-R? (w/Examples) + FAQs

This article reflects federal IRS rules as of June 2026 and covers tax year 2025 (the return most people file in early 2026) and the 2026 tax year. It also notes state treatment, using Pennsylvania as the key example. Tax law changes — confirm current figures and forms before you file.

Quick Answer

A fully tax-free 1035 exchange is reported on Form 1099-R with code 6 in box 7, the contract value in box 1, and $0 in box 2a (taxable amount). You report nothing as income on your Form 1040 for tax year 2025. Only the taxable part of a partial exchange is taxed.

You swapped one insurance product for another — a life policy, an annuity, or a long-term care contract — and a 1099-R landed in your mailbox with a “6” in box 7. The fear is normal: a 1099-R usually means taxable income, and seeing one after a tax-free move makes people think the IRS expects a check. It does not. Code 6 is the IRS shorthand for “this was a tax-free section 1035 exchange, so no tax is due.”

The stakes are real, though, because the form must still be entered on your return correctly, and a partial exchange or a canceled policy loan can quietly turn part of the deal into taxable income. According to the IRS data book, the IRS processes well over 5 billion information returns like the 1099-R each year, and its computers match every one against your 1040 — so a form left off your return, even a tax-free one, can trigger an automated notice.

Here is what you will walk away knowing:

🧾 How to read every box on a code 6 Form 1099-R, line by line.
💵 How to enter the exchange on your Form 1040 so the IRS matching system stays quiet.
⚠️ When a “tax-free” exchange is actually partly taxable — and how to report that part.
🏛️ How the issuing company decides whether to even send a 1099-R, and what to do if one is missing.
🗺️ How states like Pennsylvania treat the exchange, plus the mistakes that cost real money.

What a 1035 Exchange Actually Is

A 1035 exchange is a tax-free swap of one insurance or annuity contract for another, named after Section 1035 of the Internal Revenue Code. Congress lets you move the cash value from an old contract into a new one without paying tax on the gain, as long as you trade like for like under the rules. The point is to let people upgrade outdated policies or annuities without a tax penalty for doing so.

The catch is that not every swap qualifies, and the consequence of getting it wrong is steep: a disqualified “exchange” becomes a full surrender, and the entire gain becomes taxable income in one year. So the law spells out exactly which trades are allowed.

Which Swaps Qualify

The IRS 1099-R instructions list the allowed exchanges under section 1035. You can trade:

A life insurance contract for another life policy, an endowment, an annuity, or a qualified long-term care (LTC) contract.
An endowment contract for another endowment, an annuity, or a qualified LTC contract.
An annuity contract for another annuity or a qualified LTC contract.
A qualified long-term care contract for another qualified LTC contract.

Notice the one-way street: you can move toward an annuity or LTC contract, but you cannot exchange an annuity back into a life insurance policy tax-free. The consequence of trying is that the IRS treats it as a taxable surrender. The fix is simple — confirm the direction of your swap before you sign, because the issuing company will report it based on what actually happened, not what you intended.

Why the Exchange Is Tax-Free

The gain inside an old contract is not erased; it is carried over into the new contract along with your cost basis. You only postpone the tax, you do not cancel it. The consequence matters later: when you eventually surrender the new contract or take distributions, the old gain is still waiting to be taxed.

A common misconception is that a 1035 exchange “resets” your basis to the new contract’s value. It does not. Your original investment (basis) follows you into the new contract, so keep every statement showing what you paid — that paperwork is what proves the tax-free treatment if the IRS ever asks.

Why You Got a 1099-R After a Tax-Free Move

The issuing company sends a Form 1099-R because most 1035 exchanges between two different companies are reportable, even though no tax is due. Per the IRS instructions, these contract exchanges “are generally reportable on Form 1099-R,” and the company uses code 6 to flag the move as tax-free. The form is an information report, not a tax bill.

The consequence of ignoring it is the danger: the IRS receives its own copy and matches it to your Social Security number. If the form never appears on your 1040, the matching system can flag it and mail you a CP2000 notice proposing tax on the full box 1 amount. You then have to write back and prove it was tax-free — work you avoid by simply entering the form correctly the first time.

When No 1099-R Is Required

Not every exchange generates a form. The IRS instructions say reporting is not required when all three of these are true: the exchange happens within the same company, it is a pure contract-for-contract swap with no cash paid out, and the company keeps adequate records of your basis. For example, a life policy from Company X swapped solely for another life policy from Company X needs no 1099-R if Company X tracks your basis.

A common misconception is that “no 1099-R” means “no record-keeping needed.” The opposite is true. When the company carries your basis forward without a form, you should still keep proof of the exchange, because there is no IRS document backing up your numbers if you surrender the new contract years later.

Reading Your Code 6 Form 1099-R: Box by Box

The 1099-R has more than a dozen boxes, but only a handful matter for a 1035 exchange. Each box tells the IRS a specific fact, and reading them together tells you whether you owe anything. For a clean, fully tax-free exchange, the math should add up to zero taxable dollars.

The consequence of misreading a box is real money. If you assume box 1 (gross amount) is taxable income, you could overpay thousands; if you ignore a second 1099-R reporting a taxable loan payoff, you could underpay and face a penalty. Here is what each key box means.

Box 1 — Gross Distribution

Box 1 shows the total contract value that moved in the exchange. This number can look alarming — it may be a six-figure amount — but in a tax-free exchange it is not income. It is simply the size of the value that transferred from the old contract to the new one. The consequence of treating box 1 as taxable is overpaying tax you do not owe, so always read box 1 together with box 2a before reacting.

Box 2a — Taxable Amount

Box 2a is the box that decides your tax. For a fully tax-free 1035 exchange, box 2a should read $0 (or 0.00). That zero is the company telling the IRS that none of the gain is being taxed now. If box 2a shows a number greater than zero, part of your exchange was taxable — usually because cash or a loan payoff was involved — and that amount flows to your return as income. Always confirm this box matches what you expected from the deal.

Box 5 — Employee Contributions / Basis

Box 5 often reports your cost basis — the after-tax money you put into the contract. In an exchange it helps document the basis carrying forward into the new contract. Keep this figure with your records, because it reduces the taxable gain when you eventually cash out the new contract. The consequence of losing it is paying tax twice on money you already paid tax on once.

Box 7 — Distribution Code

Box 7 is the heart of the matter. A code 6 means a “tax-free section 1035 exchange of life insurance, annuity, or endowment contracts,” per the Form 1099-R code list. Seeing code 6 is the signal that the move was tax-free. If you instead see code 7 (normal distribution) or code 1 (early distribution), the company did not treat your move as a 1035 exchange, and you should call them before filing, because that changes everything about your tax.

Which Situation Applies to You?

The right reporting depends on your facts. Find your situation below and follow the matching section.

Clean swap, different companies, no cash taken: You will get one 1099-R with code 6 and $0 in box 2a. Enter it; owe nothing. See “How to Report It on Your 1040.”
Swap within the same company, no cash: You likely get no 1099-R. Keep your own records; report nothing. See “When No 1099-R Is Required.”
Partial exchange — you also took cash (“boot”): You get a code 6 form plus a separate taxable 1099-R. The cash is taxed. See “Partially Taxable Exchanges.”
Old contract had a loan that was canceled: The canceled loan may be taxable and reported on a separate form. See “Partially Taxable Exchanges.”
Annuity-to-annuity for income payments: Code 6 still applies to the exchange itself; later income payments are reported separately when they begin.

How to Report It on Your Form 1040

For a fully tax-free exchange, you enter the 1099-R on your return but report $0 of it as taxable. The form flows to the Form 1040 pension and annuity lines. You are telling the IRS, “I received this form, and here is why none of it is taxable.”

The consequence of skipping the entry entirely — even though it is tax-free — is an IRS matching notice, so always enter the form rather than ignoring it. Here is the step-by-step.

Enter the gross amount from box 1 on Form 1040, line 5a (pensions and annuities) if it is an annuity, or line 6a if it is reported as a pension-type distribution.
Enter the taxable amount from box 2a — which is $0 — on line 5b (or 6b). The taxable line stays zero.
In tax software, type the 1099-R exactly as printed, including code 6 in box 7; the software then carries $0 to the taxable line automatically.
Keep the form, the exchange paperwork, and your basis records for at least three years after filing, in case of a matching question.

A common misconception is that you must attach a special form or statement to “explain” the exchange. You do not — the code 6 on the 1099-R is the explanation. Your only job is to enter the form accurately so box 2a’s zero reaches your taxable line.

Worked Example: Fully Tax-Free Annuity Swap

Maria, age 62, owns a variable annuity at Company A worth $140,000, of which $90,000 is her original after-tax investment and $50,000 is gain. She does a direct 1035 exchange into a new fixed-indexed annuity at Company B, taking no cash.

Box 1 (gross): $140,000
Box 2a (taxable): $0
Box 5 (basis): $90,000
Box 7 (code): 6

On her Form 1040, Maria writes $140,000 on line 5a and $0 on line 5b. Her tax bill from this move is zero. The $50,000 gain rides into the new annuity, where her $90,000 basis still applies — so when she surrenders it years later, only the gain above $90,000 is taxed.

Partially Taxable Exchanges (the “Boot” Trap)

A 1035 exchange stops being fully tax-free the moment you receive something other than the new contract — known as “boot.” The two most common forms of boot are cash taken out during the swap and the cancellation of a policy loan on the old contract. Per the IRS instructions, “the distribution of other property or the cancellation of a contract loan at the time of the exchange may be taxable and reportable on a separate Form 1099-R.”

The consequence is that you receive two forms: a code 6 form for the tax-free part and a separate form (often code 7) for the taxable part. Miss the second form and you underreport income, which can trigger tax plus interest and an accuracy penalty. The taxable amount is generally the lesser of the boot received or the gain in the contract.

Worked Example: Annuity Exchange With Cash Taken

David exchanges an annuity worth $100,000 (basis $60,000, gain $40,000) into a new annuity but pulls out $15,000 in cash to cover a bill. The cash is boot.

Form 1: code 6, box 1 = $85,000, box 2a = $0 (the tax-free portion moving to the new annuity).
Form 2: code 7, box 1 = $15,000, box 2a = $15,000 (the taxable cash, because gain of $40,000 exceeds the $15,000 taken).

David reports $15,000 of taxable income on line 5b and owes ordinary income tax on it. Because he is under 59½, that $15,000 may also face the 10% early-distribution penalty on Form 5329 — roughly $1,500 extra. The fix to avoid all of this is to not take cash during the exchange.

Worked Example: Life Policy With a Loan

Susan exchanges a life insurance policy with $80,000 of cash value, $70,000 basis, and a $20,000 outstanding policy loan into a new policy. The new insurer will not carry the loan, so it is paid off (canceled) from the cash value during the exchange.

The canceled $20,000 loan is treated as boot. Because her gain is only $10,000 ($80,000 value minus $70,000 basis), the taxable amount is the lesser of the boot or the gain — so $10,000 is taxable, reported on a separate 1099-R. Susan reports $10,000 of income; the rest of the exchange stays tax-free under code 6.

Three Common Scenarios at a Glance

These three patterns cover most code 6 situations a typical filer faces.

Exchange Situation	How It Is Reported and Taxed
Clean swap between two different companies, no cash, no loan	One Form 1099-R, code 6, box 2a = $0; enter on 1040 line 5a, taxable line 5b = $0; no tax due
Same-company contract-for-contract swap, no cash	Often no 1099-R issued; keep your own basis records; report nothing
Swap where you took cash or had a loan canceled	A code 6 form for the tax-free part plus a separate taxable form; the boot amount is taxed as ordinary income

Three Named Examples

Robert (life-to-annuity, clean): Robert, 70, swaps a paid-up whole life policy worth $200,000 directly into an income annuity. He gets one code 6 form, box 2a = $0, and reports $200,000 on line 5a, $0 on line 5b. He owes nothing now; future annuity payments will be taxed as they arrive.

Lena (same-company swap): Lena moves from one Company Z annuity into a newer Company Z annuity. Because it is within the same company and she takes no cash, Company Z carries her basis forward and issues no 1099-R. She keeps the confirmation letter for her files and reports nothing.

Carlos (partial exchange): Carlos exchanges a $120,000 annuity (basis $50,000) into a new one but withdraws $10,000 cash. He receives a code 6 form for $110,000 and a separate code 7 form showing $10,000 taxable. He reports $10,000 on line 5b and, being 55, also owes the 10% penalty of about $1,000.

State Tax Treatment

Start with the federal rule, then check your state, because states do not automatically follow federal law. Most states that have an income tax conform to the federal treatment, so a fully tax-free 1035 exchange (box 2a = $0) is also tax-free at the state level and adds nothing to your state taxable income.

Pennsylvania is the classic example worth knowing. The Pennsylvania Department of Revenue does not tax a properly executed 1035 exchange, but its rules for the taxable boot portion differ from the federal cost-recovery method, so the taxable number on a PA return can differ from the federal one. The consequence of assuming PA mirrors the federal figure is a mis-filed state return.

Filers in no-income-tax states — such as Florida, Texas, and Washington — have an even simpler answer: there is no state income tax to worry about for any portion of the exchange. The fix for everyone else is to confirm your specific state’s annuity rules before filing, since conformity genuinely varies.

Deadlines, Costs, and Timing

The company must furnish your Form 1099-R by January 31 following the year of the exchange and file its copy with the IRS by February 28 (paper) or March 31 (electronic), per the general 1099 instructions. Your job is to include the form on your April 15, 2026 return for a 2025 exchange (or the next business day if the 15th falls on a weekend or holiday).

The exchange itself, done as a direct insurer-to-insurer transfer, usually takes two to six weeks to complete. The cost of reporting it is $0 if you self-prepare a clean code 6 form; a partial exchange with boot may warrant a tax preparer, typically $200–$500, or a CPA for complex life-insurance-with-loan cases.

Mistakes to Avoid

Treating box 1 as taxable income. This makes you overpay tax on money that was never taxable, sometimes by thousands of dollars.
Leaving the 1099-R off your return entirely. Even tax-free forms must be entered; omitting one can trigger an IRS CP2000 matching notice and a proposed tax bill.
Ignoring a second 1099-R for boot. Missing the taxable form means underreporting income, leading to back tax, interest, and an accuracy penalty.
Taking cash during the exchange. Any cash pulled out becomes taxable boot, defeating the purpose of a tax-free move.
Forgetting the policy loan. A canceled loan on the old contract can be taxable boot even when you receive no cash in hand.
Assuming basis resets. Your old cost basis carries over; treating the new contract’s full value as basis causes you to overpay tax at the final cash-out.
Trying a disallowed direction. Swapping an annuity back into life insurance does not qualify, so the company reports a fully taxable surrender instead.
Assuming your state follows federal rules. States like Pennsylvania compute the taxable portion differently, so a copied federal number can produce a wrong state return.

Do’s and Don’ts

Do enter every 1099-R you receive, even a tax-free code 6 — because the IRS matches each form to your return.
Do confirm box 2a reads $0 before assuming the exchange was fully tax-free — because that box, not box 1, decides your tax.
Do keep your old contract’s basis records — because they cut your taxable gain when you eventually cash out.
Do request a direct insurer-to-insurer transfer — because money never touching your hands keeps the swap clean and tax-free.
Do call the issuer if you see code 7 or 1 instead of 6 — because a wrong code means a wrong tax result before you even file.
Don’t take cash out during the exchange — because that cash is taxable boot and may add a 10% penalty.
Don’t swap an annuity into a life policy — because that direction is not allowed and triggers a full taxable surrender.
Don’t ignore an outstanding policy loan — because canceling it during the swap can create taxable income.
Don’t assume “no 1099-R” means “no records” — because you still need proof of basis for the future.
Don’t guess your state’s treatment — because conformity varies and a wrong assumption mis-files your return.

Pros and Cons of a 1035 Exchange

Pro — Tax deferral: You move the gain into a new contract without paying tax now, because section 1035 postpones the tax.
Pro — Basis carries over: Your original investment follows you, so you do not lose credit for after-tax money already paid in.
Pro — Better contract: You can upgrade to lower fees, stronger features, or a more solvent insurer without a tax penalty.
Pro — No income limit: Anyone with an eligible contract can do it, because section 1035 has no income phase-out.
Pro — Adds LTC options: You can move an annuity or life value into a qualified long-term care contract tax-free.
Con — Surrender charges: The old contract may impose a back-end charge, because many annuities lock you in for years.
Con — New surrender period: The replacement contract often restarts a multi-year surrender schedule, reducing flexibility.
Con — Boot is taxable: Any cash or canceled loan is taxed, so the move is only tax-free if you take nothing out.
Con — Tax is deferred, not erased: The old gain is still taxable later, because the exchange only postpones it.
Con — Possible penalty: Taxable boot taken before 59½ can face the extra 10% early-distribution penalty.

What to Do Next

Find your Form 1099-R (mailed by January 31) and check box 7 for code 6 and box 2a for the taxable amount.
If box 2a is $0, enter the form on your 1040 lines 5a/5b (or 6a/6b) with $0 taxable; you owe nothing.
If you received any cash or had a loan canceled, look for a second 1099-R and report that taxable amount as income.
Gather and file your old contract’s basis records with your tax documents, even if no form was issued.
If a wrong code appears (7 or 1 instead of 6), call the issuing company before April 15 to request a corrected form.
Call a CPA or tax attorney if your exchange involved a policy loan, partial boot, or a possible early-distribution penalty — they typically charge $200–$500 for this and can confirm the taxable amount.

This guide is educational and is not a substitute for advice from a licensed tax professional about your specific contracts and state.

FAQs

Do I owe tax on a 1035 exchange with code 6 on my 1099-R?

No. A code 6 1035 exchange is tax-free, so box 2a should show $0 and you owe no tax for tax year 2025. You still must enter the form on your return so IRS matching does not flag it.

Do I have to report a 1035 exchange if I never received a 1099-R?

No, you report no income, and no 1099-R is required when the swap is within the same company with no cash taken and the insurer tracks your basis. Keep your own records of the exchange and basis.

What does code 6 in box 7 mean?

A tax-free section 1035 exchange of life insurance, annuity, endowment, or qualified long-term care contracts. It tells the IRS the value moved between contracts without being taxed.

Where do I enter a 1035 exchange on Form 1040?

On lines 5a and 5b (pensions and annuities). Put box 1 on line 5a and the $0 from box 2a on line 5b, so no taxable income is added.

Is the box 1 amount on my 1099-R taxable?

No, not by itself. Box 1 is the gross contract value that moved; the taxable figure is box 2a, which is $0 for a fully tax-free exchange. Read the two boxes together.

Can part of a 1035 exchange be taxable?

Yes. If you take cash (“boot”) or a policy loan is canceled during the swap, that amount is taxable and reported on a separate 1099-R, usually with code 7.

Why did I get two 1099-R forms for one exchange?

Because part of the exchange was taxable. One form (code 6) reports the tax-free portion, and a second reports the taxable boot — cash received or a canceled loan.

Will I owe a 10% penalty on a 1035 exchange?

No, not on the tax-free part. But if you took taxable cash before age 59½, that boot can face the 10% early-distribution penalty, reported on Form 5329 for tax year 2025.

Can I exchange an annuity for a life insurance policy tax-free?

No. Section 1035 does not allow an annuity-to-life-insurance swap; the IRS treats it as a full taxable surrender. You may move a life policy into an annuity, but not the reverse.

Does my state tax a 1035 exchange?

Usually no if your state conforms to federal law, which most do. Pennsylvania does not tax a proper exchange but computes any taxable boot differently, and no-income-tax states like Florida do not tax it at all.

What if my 1099-R shows code 7 instead of code 6?

Call the issuing company. Code 7 means a normal taxable distribution, not a 1035 exchange. If the swap qualified, request a corrected 1099-R before you file your 2025 return.

Does a 1035 exchange reset my cost basis?

No. Your original basis carries into the new contract. Keep the records, because that basis reduces your taxable gain when you eventually surrender the replacement contract.

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