A recent Internal Revenue Service revenue ruling has finally settled the debate over whether the assets in an irrevocable grantor trust can get a step-up in basis at the grantor’s death. Revenue Ruling 2023-2 makes clear that there’s no step-up in basis.
For years, practitioners have anticipated guidance from the IRS as to whether assets held in an irrevocable grantor trust that were removed from the grantor’s estate for federal estate tax purposes, but which remained taxable to the grantor for income tax purposes under Internal Revenue Code Sections 671-679, could receive a step-up in basis on the grantor's death. Some commonly refer to such trusts as “grantor trusts,” “intentionally defective grantor trusts” or “IDGTs.” These trusts are popular, in part, as an “estate tax freeze” because such trusts can remove the appreciation on assets held by the trust that occurs after the assets are gifted or acquired by the trust from federal estate taxation at the grantor’s death.
An additional reduction in the size of the grantor’s estate also results from the “tax burn” associated with the grantor’s obligation to personally report and be responsible for income tax consequences of such a trust. That’s because the grantor’s payment of the income tax isn’t treated as an additional gift.
Differing Views
Some have argued that IRC Section 1014(a) provides an additional benefit in the form of a step-up in basis on assets of the trust at the grantor’s death. (Jonathan G. Blattmachr, Mitchell M. Gans, and Hugh H. Jacobson, "Income Tax Effects of Termination of Grantor Trust Status by Reason of the Grantor's Death," 97J. Tax'n149 (2002).)
Many other planners believed a step-up in basis generally wasn’t possible if the assets weren’t included in the grantor’s estate for federal estate tax purposes. To address the income tax ramifications associated with the loss of the ability to obtain a step-up to the fair market value (FMV) of the asset at the grantor’s death, many grantor trusts include a power of substitution so that a grantor might “swap” out low-basis assets for cash or higher-basis assets of equivalent value.The swap power is just one of a number of powers or transactions that might result in an irrevocable trust that holds completed gifts being taxable for income tax purposes to the grantor.
Revenue Ruling 2023-2
Rev. Rul. 2023-2 makes clear the IRS’ position in the debate regarding whether a grantor trust generally will be afforded a step-up in basis under Section 1014 when the property at issue isn’t includible in the grantor’s gross estate for federal estate tax purposes. (Rev Rul. 2023-2, at fn 4, clarifies that this ruling doesn’t alter the results of Rev. Rul. 84-139, with regard to property acquired from a nonresident noncitizen decedent that wasn’t included in the decedent’s gross estate, but was acquired by bequest, devise or inheritance or one of the other six types of property considered to be acquired from a decedent under provisions of Section 1014(b)).
In the facts outlined in the revenue ruling, the grantor established and funded an irrevocable trust. The transfers to the trust were a completed gift for gift tax purposes. The only rights retained by the grantor were those necessary to have the grantor treated as the owner of the trust for income tax purposes. The grantor didn’t retain any power over the trust that would result in inclusion of the trust’s assets in the grantor’s gross estate for federal estate tax purposes. By the time the grantor died, the FMV of the assets of the trust had appreciated, the liabilities of the trust didn’t exceed asset basis and there were no outstanding notes between the grantor and the trust.
The revenue ruling addressed the seven types of property considered to qualify for a basis adjustment at a decedent’s death under Section 1014 and held that property is generally only considered to “have been acquired from a decedent to the extent such property is includible in the decedent’s gross estate if the decedent died after December 31, 1953.”
Under the facts presented, the property wasn’t a bequest, devise or inheritance from the decedent within the ordinary meaning of those terms and didn’t fall within one of the six other types of property listed in Section 1014(b) that qualified for basis adjustment at a decedent’s death.
Debate Settled
With the issuance of Rev. Rul. 2023-2, the IRS has clearly delineated its position and settled the debate. The basis of an asset in a grantor trust for income tax purposes, but which isn’t includible in the grantor’s gross estate for federal estate tax purposes, will remain the same as it was immediately before the grantor’s death because it doesn’t constitute a “gift, bequest or devise from a decedent.”
Sandra D. Glazier, Esq., is an equity shareholder at Lipson Neilson, P.C., in its Bloomfield Hills, Mich.,office and is a member of Trusts and Estates’Editorial Advisory Board Planning & Taxation Committee.
FAQs
A recent Internal Revenue Service revenue ruling has finally settled the debate over whether the assets in an irrevocable grantor trust can get a step-up in basis at the grantor's death. Revenue Ruling 2023-2 makes clear that there's no step-up in basis.
Do assets in irrevocable trust get stepped-up basis? ›
Irrevocable Trusts
The trust assets will carry over the grantor's adjusted basis, rather than get a step-up at death. Assets held in an irrevocable trust that has its own tax identification number (i.e., nongrantor trust status) do not receive a new basis when the grantor dies.
How do you step up basis in irrevocable trust assets? ›
The step-up in basis is equal to the fair market value of the property on the date of death. In our example, if the parents had put their home in this irrevocable income only trust, and the fair market value upon their demise was $300,000, the children would receive the home with a basis equal to this $300,000 value.
Can you use step up cost basis for irrevocable trust? ›
Rul. 2023-2, the IRS determined that the basis “step-up” under section 1014 does not apply to assets gifted to an irrevocable grantor trust by completed gift in cases in which such assets are not included in the gross estate of the owner of the trust for federal estate tax purposes.
What assets do not get a step-up in basis? ›
Examples of Assets That Do NOT Step-Up in Basis
- Individual retirement accounts, including IRAs and Roth IRAs.
- 401(k), 403(b), 457 employer-sponsored retirement plans and pensions.
- Real estate that was gifted prior to inheritance.
- Tax-deferred annuities.
Capital gains are not considered income to such an irrevocable trust. Instead, any capital gains are treated as contributions to principal. Therefore, when a trust sells an asset and realizes a gain, and the gain is not distributed to beneficiaries, the trust pays capital gains taxes.
What happens to an irrevocable grantor trust when the grantor dies? ›
After the grantor of an irrevocable trust dies, the trust continues to exist until the successor trustee distributes all the assets. The successor trustee is also responsible for managing the assets left to a minor, with the assets going into the child's sub-trust.
Does a grantor trust get a step-up in basis at death? ›
The IRS has recently issued guidance (Rev. Rul. 2023-2) denying a basis adjustment under Section 1014 for property acquired from a decedent when the property is held in a grantor trust upon the death of the grantor.
Can you transfer assets out of an irrevocable trust? ›
As the Trustor of a trust, once your trust has become irrevocable, you cannot transfer assets into and out of your trust as you wish. Instead, you will need the permission of each of the beneficiaries in the trust to transfer an asset out of the trust.
What is the downside of an irrevocable trust? ›
The downside of irrevocable trust is that you can't change it. And you can't act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren't confident about the reason you're setting up the trust to begin with.
Irrevocable trusts are generally set up to minimize estate taxes, access government benefits, and protect assets. This is in contrast to a revocable trust, which allows the grantor to modify the trust, but loses certain benefits such as creditor protection.
Does step-up in basis apply to all assets? ›
The step-up in basis provision applies to financial assets like stocks, bonds, and mutual funds as well as real estate and other tangible property. Of course, if the price of an asset has declined from that paid by the owner's date of death, the asset's cost basis would step down instead of stepping up for heirs.
How do you distribute assets from an irrevocable trust? ›
The grantor can opt to have the beneficiaries receive trust property directly without any restrictions. The trustee can write the beneficiary a check, give them cash, and transfer real estate by drawing up a new deed or selling the house and giving them the proceeds.
What is the stepped-up basis loophole? ›
The stepped-up basis loophole allows someone to pass down assets without triggering a tax event, which can save estates considerable money. It does, however, come with an element of risk. If the value of this asset declines, the estate might lose more money to the market than the IRS would take.
Is step-up in basis mandatory? ›
"You can elect step up in basis on the decedent's death." No, basis adjustment is mandatory, including a step down in basis if the fair market value on death is less than the decedent's basis in the asset.
Is step up basis automatic? ›
It's also worth noting that the step-up in basis doesn't just happen automatically. You'll need to fill out paperwork with the custodian if there wasn't a financial advisor managing the accounts. Inherited real property, like a house, will need to be appraised by a professional.
How are assets in an irrevocable trust taxed? ›
An irrevocable trust reports income on Form 1041, the IRS's trust and estate tax return. Even if a trust is a separate taxpayer, it may not have to pay taxes. If it makes distributions to a beneficiary, the trust will take a distribution deduction on its tax return and the beneficiary will receive IRS Schedule K-1.
Who pays capital gains on an irrevocable trust? ›
One fundamental tax-focused decision when structuring a trust is whether the trust should be a grantor trust or a non-grantor trust. If the former, the grantor will be responsible for paying the income tax on income (including capital gains) produced by the trust assets. If the latter, the trust will pay its own taxes.
How is an irrevocable grantor trust taxed? ›
If a trust is a grantor trust, then the grantor is treated as the owner of the assets, the trust is disregarded as a separate tax entity, and all income is taxed to the grantor.
How hard is it to break an irrevocable trust? ›
Instead, in most cases, an irrevocable trust can only be dissolved by court order. The details of dissolving an irrevocable trust differ widely between states and jurisdictions. However, typically you will need to get approval from the trust's beneficiaries and potentially its trustees as well.
Do use trust assets for repairs, maintenance and improvements to real property in the trust. Do use trust assets for payment of real estate taxes and homeowners insurance. Do take dividends and income on trust assets on at least a quarterly basis.
Can a grantor remove a beneficiary of an irrevocable trust? ›
That is, they cannot be normally changed or amended. So, when asking the question “can you change beneficiaries in an irrevocable trust?” the answer is generally “no” you normally cannot change the aspects of an irrevocable trust, like changing beneficiaries.
Can assets be sold from an irrevocable trust? ›
A trustee can sell property in an irrevocable trust according to the terms provided in the documents used in the creation of the irrevocable trust. Property held in an irrevocable trust is not included in an estate, which means you don't have to pay estate taxes for that property.
What is 1014 step up basis? ›
The tax code of the United States holds that when a person (the beneficiary) receives an asset from a giver (the benefactor) after the benefactor dies, the asset receives a stepped-up basis, which is its market value at the time the benefactor dies (Internal Revenue Code § 1014(a)).
Why use an intentionally defective grantor trust? ›
An intentionally defective grantor trust (IDGT) allows a person to isolate certain trust assets to segregate income tax from estate tax treatment. It is effectively a grantor trust with a purposeful flaw that ensures the individual continues to pay income taxes.
Who controls the assets in an irrevocable trust? ›
A third-party member called a trustee is responsible for managing and overseeing an irrevocable trust.
What is the greatest advantage of an irrevocable trust? ›
An Irrevocable Trust means you can protect yourself, your loved ones and your estate against future legal action. It also means you can protect the financial future of your estate by avoiding substantial estate taxes.
Why would someone want an irrevocable trust? ›
The only three times you might want to consider creating an irrevocable trust is when you want to (1) minimize estate taxes, (2) become eligible for government programs, or (3) protect your assets from your creditors. If none of these situations applies, you should not have an irrevocable trust.
What does Suze Orman say about irrevocable trust? ›
With an irrevocable trust, as soon as the grantor transfers the assets into the trust, they remove all their rights of ownership to the trust and those assets. They can't make any decisions about how the assets should be managed, or if they should be sold.
Is an irrevocable trust subject to the 5 year rule? ›
Will An Irrevocable Trust Protect Me From The Medicaid Five Year Look Back Period? Unfortunately, it will not if you set up that irrevocable trust after the Medicaid help has been given or within 5 years before the Medicaid help has been given.
The IRS and Irrevocable Trusts
When you put your assets into an irrevocable trust, they no longer belong to you, the taxpayer (this is different from a revocable trust, where they do still belong to you). This means that generally, the IRS cannot touch your assets in an irrevocable trust.
Do beneficiaries of a trust get stepped-up basis? ›
The concept of step-up in basis is actually quite simple. A trust or estate and its beneficiaries, or payable on death beneficiaries, get a step-up in basis to fair market value of the asset so received. That value is stepped up to the fair market value of the asset as of the date of death of the Decedent.
What is the step-up in basis for assets held in trust? ›
A Step-Up in Basis means that the asset's value has risen from the time it was purchased. The Step-Up in Basis value of an asset is calculated by assessing the fair market value of that asset on the date of its original owner's death, upon which the asset is passed to a designated heir, often through an Estate Plan.
Can cost basis be stepped up in a trust? ›
A step-up in basis is a tax advantage for individuals who inherit stocks or other assets, like a home. A step-up in basis could apply to stocks owned individually, jointly, or in certain types of trusts, like a revocable trust. Sometimes called a loophole, the step-up cost basis rules are 100% legal.
Do I have to pay taxes on money from an irrevocable trust? ›
Irrevocable trust distributions can vary from being completely tax free to being taxable at the highest marginal tax rates, and in some cases, can be even higher.
What is step-up in basis and irrevocable trust? ›
Typically, assets you place in trust for your beneficiaries are eligible for a step-up in basis if the trust is revocable, and therefore considered part of your taxable estate. But with an irrevocable trust (which exists outside of your estate), trust assets do not receive a step-up in tax basis.
Who gets a step-up in basis? ›
Due to the passing of the benefactor, the heir will receive a step up in basis to the fair market value at the time of the benefactor's death.
What are the risks of an irrevocable trust? ›
The downside of irrevocable trust is that you can't change it. And you can't act as your own trustee either. Once the trust is set up and the assets are transferred, you no longer have control over them, which can be a huge danger if you aren't confident about the reason you're setting up the trust to begin with.
What is the stepped-up basis loophole for capital gains? ›
Stepped-up basis is a tax provision that allows heirs to reduce their capital gains taxes. When someone inherits property and investments, the IRS resets the market value of these assets to their value on the date of the original owner's death.
How does an irrevocable trust avoid taxes? ›
How an Irrevocable Trust Works. Irrevocable trusts are primarily set up for estate and tax considerations. That's because it removes all incidents of ownership, removing the trust's assets from the grantor's taxable estate. It also relieves the grantor of the tax liability on the income generated by the assets.
