Property, such as your home, held in an irrevocable trust 'that is not included in the taxable estate at death' will no longer receive a step-up in basis. Here’s why the wording of that is key.

In March, the IRS issued Revenue Ruling 2023-2, which had a substantial impact on estate planning, particularly where an irrevocable trust is involved. In the last decade or so, more families have begun utilizing irrevocable trusts to protect their assets from spend-down in order to qualify for government benefits, such as Medicaid and VA Aid and Attendance.

Why Do I Need a Trust?

Prior to the issuance of this ruling, it was unclear whether assets passing to beneficiaries through an irrevocable trust would receive a step-up in basis, thereby eliminating any capital gains taxes that would otherwise be owed. Historically, assets that are disposed of during an individual’s lifetime are subject to capital gains taxes on the increase in value of that asset over time. The amount of capital gains owed is determined largely by the difference between the value at the time of purchase and the value at the time of transfer.

An exception to the obligation of capital gains taxes has been when assets pass at the death of the owner to their beneficiaries. The death of the owner bestows upon the recipients a step-up in basis, so they inherit the asset as if it had been purchased at the current fair market value, not the value at the time the asset was actually purchased. This eliminates any capital gains, and so no taxes become due.

What about an irrevocable trust?

But what to do about assets in an irrevocable trust? They are not currently held by the purchaser of the asset, nor have they passed to the beneficiaries. Prior to March 2023, such transfers from the trust at death have been generally receiving the step-up in basis. But that may not be the case any longer. This new ruling by the IRS states that property held in an irrevocable trust that is not included in the taxable estate at death will not receive a step-up in basis any longer.