How to figure cost basis for foreign insurance policy that was traded in?

April 18, 2006 8:32 PM

[tax filter] I cashed in a UK endowment policy in 2005. I was paying GBP X per month from Sep 1989 until Apr 2005, and then sold the policy for GBP Y. What is the cost basis for US tax purposes? [more inside]

I moved from the UK to the US in Jan 1994.

How do I figure the cost basis for this for US tax purposes?

Do I simply multiply GBP X by the number of payments and convert GBP to USD as at the redemption time?

Or do I convert GBP X to USD at the point of each monthly payment, and add up the USD?

Or do I use the first method up until Jan 1994, convert the accumulated GBP to USD at Jan 1994, and then use the second method?

It makes a big difference as to the amount of the gain.

(Yes, I know it would have been nice to know this yesterday...)

Bonus Question: Is the gain a capital gain or straight income?

posted by blue_wardrobe to Work & Money (2 answers total)

If it were all in US dollars, it would be pretty straightforward: Add up all your Xs, subtract that from Y. That's your gain.

Capital gains are, I believe, fairly narrowly defined. Your endowment sounds like a capital gain to me, but on paper, it may not be. I'd suggest reading the IRS definition of capital gains very closely. You _really want_ for it to be a capital gain... if it's regular income, you're gonna get killed.

With the payments being in GBP, that complexifies it a bit. I'd suggest running the numbers where you convert the value both at the exchange rate when you cashed the policy, and the exchange rate at the time you made the payments. (if you made monthly payments, that could take a long while.) I don't think yearly averages would be adequate.. you'd have to measure it in US $ at the exact time you made the payment.

Use whichever numbers are most favorable for you. If the IRS subsequently rules against you, and forces you to choose the worst approach, I'd suggest fighting it, if it's a significant difference.

Worst case, it's not likely they'll make you pay a penalty, since you'll have a well-reasoned justification. But if they do rule against you, you will have to pay the extra tax.
posted by Malor at 9:42 PM on April 18, 2006

Response by poster: I have run the numbers both ways already -- I used www.oanda.com to generate a table of daily FX rates, and a little excel-fu. Took about five minutes. The effort is not in the calculation. It's in finding the (non-existent?) rules.
posted by blue_wardrobe at 9:54 PM on April 18, 2006