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Your irrevocable trust may be affected by this IRS rule change

by | Jul 26, 2023 | Estate Planning & Wealth Management

People with assets in an irrevocable trust may want to update their estate plan to account for the IRS closing a popular capital gains tax loophole, effective March 2023, regarding the step-up in basis.

What is a “step-up in basis?”

The term refers to an irrevocable trust perk that allowed people to eliminate capital gains taxes on high-value assets like homes and investments when they are passed to beneficiaries upon their death.

Typically, an asset is taxed based on the difference in value between its purchase and its sale, or for estate planning, your death. For example, a house you purchased in 2003 for $200,000 that is valued at $500,000 when you pass away in 2023 will be taxed based on its $300,000 increase in value.

But a house in an irrevocable trust formerly enjoyed a “step-up in basis” value reset, as if the house had been purchased this morning for $500,000. Thus, the capital gains tax owed by your beneficiaries for that far more valuable house would nevertheless be $0.

With the IRS rule change, that gravy train has seemingly left the station. Or has it?

Why did the IRS do this and how will it affect me?

In short, the IRS wants beneficiaries to pay more estate taxes. Eliminating the irrevocable trust step-up in basis is a simple way to accomplish that.

However, many of us won’t see a difference while the federal estate tax only applies to estates worth more than $12.92 million per individual – or $25.84 million for married couples. Even when that number is cut in half in 2026 (barring legislative intervention), most of us won’t have to sweat estate taxes, even with the house’s value thrown in.

That said, it’s probably in your best interest to talk to an estate planning attorney and a tax accountant to see how this IRS rug-pull will affect you personally, if at all.

How does Medicaid factor into all of this?

If you already have an irrevocable trust, and you’re not a multi-millionaire, you know that the main point of the trust is to side-step some of the asset spend-down processes you must go through before reaching the minimum total asset value that qualifies you for Medicaid.

The trust means your $500,000 house lives in an ownerless limbo. No need to sell it while you’re alive and pay capital gains taxes and no need for your beneficiaries to do the same when the house is sold and the money is transferred to them after you pass. Everyone wins (except the IRS).

This IRS pivot aside, irrevocable trusts are still useful for the aforementioned Medicaid asset management angle. Consult an estate planning attorney to find out how, or if, a trust is a good idea for your situation.