Estate planning often involves navigating complex tax considerations, and a recent IRS rule change adds a new layer of complexity. This rule, issued at the close of March, modifies how the step-up in basis applies to assets held within irrevocable trusts. If you find the IRS rule change perplexing or need assistance in structuring your estate plan, consulting with a financial advisor may be a wise step to take.
Understanding the Step-Up in Basis
The step-up in basis is a key concept in estate planning. When someone inherits an asset that has unrealized capital gains, the asset’s basis resets or “steps up” to its current fair market value. This reset effectively erases any tax liability associated with the previously unrealized capital gains.
For example, if you bought stock over a year ago for $100,000 and later sold it for $250,000, you would typically owe capital gains tax on the $150,000 profit over the original $100,000 basis. However, if you inherit the same stock, your new basis steps up to $250,000, and you’ll only incur tax if you sell the stock for more than that amount.
To safeguard their assets, many individuals place them in irrevocable trusts, which relinquishes their ownership rights in favor of the trust’s beneficiaries.
How the IRS Rule Change Affects Irrevocable Trusts
Previously, the IRS granted the step-up in basis for assets within an irrevocable trust. However, the recent ruling, Rev. Rul. 2023-2, alters this practice. The basis now does not reset unless the assets are included in the taxable estate of the original owner or “grantor.” To secure the step-up in basis, assets within the irrevocable trust must be part of the taxable estate at the grantor’s time of death.
The downside is clear. The upside, however, is that due to the 2023 per-person exclusion of $12.92 million (or $25.84 million for married couples), very few estates in the U.S. will be liable for estate taxes.
In 2021, only 6,158 estates had to file estate tax returns, and just 2,584 of them (42%) paid any taxes at all. By incorporating irrevocable trust assets into the taxable estate, beneficiaries of the trust can bypass the tax obligation and receive the step-up in basis. It’s essential to note that this situation might change for some individuals in 2026 when the estate tax exemption limit reverts to the 2017 amount of $5 million, adjusted for inflation.
Why Use an Irrevocable Trust?
Irrevocable trusts are often used for various reasons. One common purpose is to remove assets from personal ownership to qualify for Medicaid nursing home assistance. For instance, a parent may place a home valued at $500,000 into the trust, allowing them to qualify for Medicaid. Then, by incorporating the home into their taxable estate, they can pass it on to their children without incurring taxes, with the basis remaining at $500,000.
In Conclusion
Anyone employing an irrevocable trust should carefully review their estate plan to ensure it complies with the updated IRS rule and preserves the step-up in basis for assets intended for their heirs. Crafting a robust estate plan is a prudent move that most individuals should consider to minimize potential complications for their family in the future.
Financial Planning Tips
A financial advisor can help you navigate critical rule changes to maintain the stability of your financial plan. Finding a suitable financial advisor can be straightforward. SmartAsset’s free tool connects you with up to three certified financial advisors in your area, allowing you to interview them at no cost to identify the right advisor for your needs. If you’re prepared to secure an advisor who can help you achieve your financial objectives, start the process now.
Additionally, life insurance can play a pivotal role in the financial planning process, ensuring the protection of your loved ones in case of unexpected events. SmartAsset provides a life insurance tool specifically designed to assist you in determining the coverage you require.
