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The Heritage Law Center, LLC Blog

Recent News: A Step-up in Basis and Irrevocable Trusts

POSTED ON: July 25, 2023

Recently, there’s been news about how a new IRS ruling (Revenue Ruling 2023-2) in March 2023 affects the step-up in basis for certain irrevocable trusts. There are several types of irrevocable trusts, and it’s important to understand that this ruling only affects irrevocable trusts designed to exclude trust assets from the grantor’s estate. These types of irrevocable trusts are often used by people with a high net-worth to gift assets away during life so that their estate tax is reduced. Irrevocable trusts created for Medicaid/MassHealth planning won’t be affected by this ruling.

In order to understand the new ruling, let’s provide an overview of certain terms.

What is Capital Gains Tax?

Capital gains tax applies to any profit you make on the sale of capital assets, including bonds, property, vehicles, collectibles, antiques, cryptocurrencies, and businesses. The amount of capital gains tax owed is largely determined by the difference between the asset’s value at the time of purchase and the value at the time of transfer (also known as the asset’s appreciation).

Let’s say Sam and Cindy bought an investment property in the year 2000 for $200,000, and then sold it in 2022 for $400,000. Their investment increased in value by $200,000, so they would pay capital gains tax on that $200,000 profit.

What is the Step-Up In Basis?

The step-up in basis adjusts the value of an inherited asset when it’s passed on after death. It allows someone to pass property onto their beneficiaries without paying taxes on the appreciation of that property. When a person inherits property, the value of that property is the current market value on the date of the owner’s death, not the market value on the date the deceased person bought the house.

Now, let’s talk about the ruling and two types of trusts.

The News: Revenue Ruling 2023-2 and the Irrevocable Grantor Trust

With an irrevocable grantor trust, the grantor (person who created the trust) sometimes continues to own the trust’s assets and property for income tax purposes even though the assets are excluded from their estate when calculating the estate tax. It’s typically used by very wealthy people who want to give away assets while they are alive in order to reduce the amount of estate tax when they pass away. This new IRS ruling says that property in an irrevocable trust that isn’t included in your taxable estate at death won’t get a step-up in basis. The likely goal of this decision is to make sure that more estates are subject to paying estate taxes.

An Irrevocable Trust for MassHealth Planning

This is a type of irrevocable trust that we often do for clients who want to plan in advance for MassHealth. The good news is that the Revenue Ruling 2023-2 doesn’t affect this type of trust at all.

An irrevocable trust for MassHealth planning is designed to keep the assets in your estate precisely to retain the step-up in basis. Let’s say Sam and Cindy put their house in this type of irrevocable trust in 2015. They both pass away in 2023. Their daughter Lynn is the beneficiary of their trust. She sells the house from a cost basis of $400,000, not the $200,000 originally paid for the home in 2000 (because of the step-up in basis), so no capital gains would be due.

Advantages of an irrevocable trust for MassHealth planning:

  • Protection of assets from MassHealth: As long as assets are placed in the trust five years before you apply for MassHealth for long-term care, they won’t be considered as part of your countable assets for MassHealth eligibility. The assets in your irrevocable trust will be passed on to your loved ones.
  • Avoids probate
  • Maintains the step-up in basis

To learn more about estate planning and irrevocable trusts, contact us today for a free consultation. Our trusts attorney has extensive knowledge of estate planning tools and MassHealth planning. He’ll talk to you about your goals, financial assets, and your family to create an estate plan that meets your needs and gives you peace of mind.