IRS Rule Change Should Have You Rethinking How You Leave Assets to Heirs

Brian J. O'Connor Sun, July 30, 2023

Managing your taxes can be one of the most complex aspects of estate planning and a new IRS rule change continues that trend. The rule, published at the end of March, changes how the step-up in basis applies to assets held in an irrevocable trust. If you need help interpreting the IRS rule change or setting up your estate, consider speaking with a financial advisor.

What Is a Step-Up in Basis?

When someone inherits an asset with unrealized capital gains, the basis of the asset resets or "steps up," to the current fair market value, wiping out any tax liability for the previously unrealized capital gains.

For example, if you purchased stock for $100,000 more than a year ago and sold it now for $250,000, you would pay capital gains tax on the $150,000 profit above the original basis of $100,000. If you inherit that stock, however, your new basis steps up to $250,000 and you'll pay tax only if you sell the stock for more than that amount.

To protect their assets, many people place them in an irrevocable trust, which means they lose all ownership rights to the assets. Instead, the trust becomes the owner of the assets for the benefit of the trust's beneficiaries.

How IRS Rule Change Impacts Irrevocable Trusts

Previously, the IRS granted the step-up in basis for assets in an irrevocable trust but the new ruling – Rev. Rul. 2023-2 – changes that.

Unless the assets are included in the taxable estate of the original owner (or "grantor"), 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.

That's the bad news.

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