It is not every day that my social media feed is filled with memes, click bait, and TikTok videos about IRS rulings, but Revenue Ruling 2023-2 caused enough shock and panic to go viral. The ruling changed how the step-up in basis applies to assets held in an irrevocable trust, which may change your entire estate planning strategy. Here is what you need to know.
What is a Step-Up in Basis?
One of the great advantages to inheriting an asset is you receive a stepped-up tax basis. For example, if you bought a cabin for $100,000 more than a year ago and sold it now for $250,000, you would have to pay capital gains tax on the $150,000 profit above the original basis of $100,000. However, if you do not sell the cabin during your lifetime, when your children inherit the cabin, they will get a new basis which is equal to the fair market value at the time of your death. If you purchased the cabin for $100,000 and pass away when it is worth $200,000, then your children receive the stepped up basis of $200,000. This allows them to turn around and sell it without having to pay capital gains taxes or will minimize the taxes they pay if they choose to sell it at a later date.
Many families take advantage of this step-up in basis and hold onto assets to pass them to the next generation who will be able to liquidate the assets without paying a hefty tax bill.
How the Ruling Impacted a Step-Up in Basis
Previously, the IRS granted the step-up in basis for assets in an irrevocable trust, but the new ruling changes that. Unless the assets are included in the taxable estate of the original owner, the basis doesn’t reset. To get the step-up in basis, the assets in the irrevocable trust now must be included in the taxable estate at the time of the grantor’s death.
Many families use irrevocable trusts to manage their estate tax obligation or to help qualify for nursing home assistance. When doing this planning, families understood that their beneficiaries would get the additional benefit of a stepped-up basis, so were very liberal in funding the irrevocable trusts. I predict that irrevocable trusts will still be a strategy used in estate planning, but we now need to take extra care to analyze the capital gain tax implications on the beneficiaries.
Bottom Line
The good news is this ruling does not impact revocable trusts. However, if you have an irrevocable trust or have an estate that is above the Minnesota exemption of $3 million or the Federal Exemption of $12.92 million, then it is time to consult with your experts.
