Tax laws and regulations can be tricky, particularly when it comes to estate planning.

Recently, the IRS issued a new ruling that clarifies how property held in an irrevocable trust will be treated for the purposes of capital gains. Now, if you have assets that are transferred to an irrevocable trust on which you are responsible for the income tax during your life, and where the value of the assets is not included in your “taxable estate at death,” the trust property will not receive a step-up in basis when it passes to the beneficiaries of the trust.

Why this is important: it affects the amount of capital gains taxes your beneficiaries will have to pay on the sale of appreciated trust assets.

First, let’s define a step-up in basis. It is an adjustment in the original cost basis of an asset—such as real estate, business interests, or securities—to the fair market value of the asset at the time of the death of the owner of the asset.

Now, an example: Let’s say that you purchased a home for $500,000 and at your death the home is transferred to an irrevocable trust for the benefit of your child. The fair market value of the home at the time of your death will be the stepped-up basis that your child has in the property. However, when your child passes away and the trust is passed down to your grandchildren, the property will not get a second step-up in basis when inherited by the grandchildren unless the irrevocable trust is drafted in such a way that the value of the property is included in your child’s gross estate for estate tax purposes.

A step-up in basis results in significant tax savings for families who are passing on property that has significantly increased in value, such as land, a home, company stock, or a family business, instead of selling or gifting it during their lifetimes.

The recent IRS Revenue Ruling 2023-2 says 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. What this change means for you: your heirs may be subject to significant capital gains taxes unless your irrevocable trust is set up correctly. This will become even more important in the next few years when the estate tax exemption is scheduled to be cut in half and a choice may have to be made between estate tax avoidance, and capital gains tax reduction.

Balancing planning objectives such as capital gains avoidance, estate tax avoidance, creditor protection, and controlling whether assets are kept in your bloodline needs to be considered when structuring any good estate plan. In addition, your plan should be drafted to be forward-thinking and flexible enough to adapt to your objectives over time.

Changes like these are why we recommend our clients enroll in the JM LAW CARES estate and legacy planning maintenance program, the best way to proactively adapt your plan to changes in estate and tax laws and regulations. To find out more, see our overview of the JM LAW CARES program.

If you have any questions or would like to set up a consultation, please contact us.

This post was created by Jessica Marchegiano, founder of JM Law and senior estate planning attorney.

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Disclaimer: Materials prepared by JM LAW, PLLC are for general informational purposes only. Educational material does not create an attorney-client relationship and is not an offer to represent you. You should not act or refrain from acting based on information provided.

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