IRS Revenue Ruling 2023-2
What does this mean for Capital Gains Tax on Trust Inheritances?
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More and more families are using irrevocable trusts for estate planning to safeguard their assets and manage taxes efficiently. Normally, when assets are sold during a person's lifetime, they can be subject to capital gains taxes. However, assets inherited by beneficiaries usually receive a step-up in cost basis, which reduces the potential tax burden. But now, the IRS has clarified the rules with Revenue Ruling 2023-2.
Key Points:
Irrevocable Trusts and Capital Gains Tax: Assets transferred to an irrevocable trust no longer receive a step-up in cost basis. This means that beneficiaries may face higher capital gains taxes when they sell these assets.
Implications for Estate Tax Planning: While most Americans are currently not subject to estate tax, this ruling may have a greater impact in 2026 when the estate tax exemption decreases. High net-worth individuals engaged in estate tax planning can no longer transfer property to an irrevocable trust and benefit from a cost basis step-up.
Complexity of Estate Plans: This ruling adds complexity to estate planning strategies involving irrevocable trusts. Individuals with more complex plans should consult with an estate planning attorney to reassess their strategy and minimize potential tax burdens for beneficiaries.
How to avoid the problem
Drafting an irrevocable trust with the power of appointment can be a strategic way to keep the asset in the grantor's estate at death and potentially avoid or minimize capital gains tax for beneficiaries. Here's how it can work:
Choose the right trust structure: The trust should be drafted as an irrevocable trust.
Incorporate a power of appointment: A power of appointment allows the grantor to decide how the trust assets are distributed upon their death. By granting the power of appointment to the beneficiaries, the grantor retains control over the assets and retains the asset in their estate.
Grant special powers: The power of appointment can be drafted to include specific instructions regarding the disposition of the trust assets. For example, the grantor can specify that the assets are to be distributed outright to the beneficiaries or held in further trust for their benefit.
Consider a limited power of appointment: A limited power of appointment allows the grantor to appoint the assets to a specific group of individuals or within certain restrictions. This can provide flexibility while still maintaining control over the ultimate distribution of the assets.
Minimize capital gains tax: By keeping the assets in the grantor's estate at death, the beneficiaries will receive a step-up in basis. This means that the value of the assets for capital gains tax purposes will be determined based on their fair market value at the time of the grantor's death, potentially reducing or eliminating capital gains tax liability for the beneficiaries.
It is crucial to consult with an experienced estate planning attorney to understand the specific requirements and implications of drafting an irrevocable trust with a power of appointment. Estate planning is complex, and professional guidance is essential to ensure the strategy aligns with your goals and complies with current tax laws and regulations.
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