If you are the recipient of an inheritance, you might be wondering what the tax treatment of the assets should be. Ultimately, when you inherit stocks in the form of a taxable brokerage account, you will typically receive a stepped-up cost basis. This is a factor that increases the value of the asset for tax purposes according to the market value at the time the person who named you a beneficiary dies.
What happens when you sell that stock?
When you sell that stock, you will need to pay capital gains taxes on the difference between the stepped-up cost basis and the sale price. For a long time now, lifetime gifts to irrevocable grantor trusts have been recognized as a staple in the estate planning process.
So, by gifting assets in this way, taxpayers can remove the gifted assets from their taxable estate upon the individual’s passing. Any appreciation that arises in regard to the assets after the date that the gift was passed along will not be subjected to estate tax at the time of your death as long as you set up the irrevocable trust in advance.
IRS clarifications for the irrevocable trust stepped-up basis
The IRS issues clarifications when it comes to the stepped-up basis of irrevocable trusts. If the assets of an irrevocable trust are not part of your gross estate when you die, then the assets will not benefit from the stepped-up basis.
Now, the IRS also put forth something known as Revenue Ruling 2023-2, which has made a significant impact on the estate planning process, especially in terms of irrevocable trusts. Over the past 10 years, more and more families have utilized irrevocable trusts as a way of protecting their assets.
That way, they can qualify for government benefits, namely Medicaid. At the time, it was not clear if assets that were being passed down to their beneficiaries would be eligible for a stepped-up basis, and understanding this was important because it was the difference between eliminating capital gains taxes and owing them.
So, in most cases, the assets that you dispose of in your lifetime will be subjected to capital gains taxes in response to the increase in value of those assets over time. In that case, the capital gains taxes that are owed will be determined by the difference between the value of the assets at the time they were purchased and the value of the assets at the time of their transfer.
Is there an exception to this ruling?
One example of an exception is when assets are passed from the owner to the beneficiaries. Those beneficiaries will receive a step-up in basis and inherit the asset as though it had been purchased at its current value in the existing fair market.
In turn, this will eliminate capital gains. However, since the assets are not recognized as part of your taxable estate, the IRS will view those gifts as ineligible for a step-up in basis at the time of your death.
Also, if your assets are placed in trusts, you should consider the income tax treatment of trust assets during your lifetime. Many trusts include powers to swap low-basis assets for higher-basis personal assets of equal value during the individual’s lifetime. This allows the lower-basis assets to receive a basis step-up by being included in your estate, while the assets with little to no gain remain in trust.
So, how does property work with an irrevocable trust?
With an irrevocable trust, you have relinquished your ownership over the assets in question. As a result, that property is no longer part of your taxable estate. So, this means that you are now liable for any income tax that the assets generate over the course of your lifetime.
Due to the exclusion of $12.92 million per person or $25.84 million per married couple, very few estates in the United States pay even close to a portion of this estate tax. If that sounds appealing, you can benefit as well by including your irrevocable trust assets as part of your taxable estate.
As a result, your heirs will dodge the consequence of a tax hit while simultaneously receiving the perks of the stepped-up basis. This situation may differ for some people when 2026 rolls around, and if you establish an irrevocable trust but it has not been adequately set up, then you are set to lose out on the benefits of the stepped-up basis. That’s because the trust must be worded in a way that ensures that the value of the assets is part of your taxable estate.
As you can see, the tax implications of the estate planning process can be mighty complex. If you opt to use an irrevocable trust, then you should make sure you review your estate plan and ensure that it complies with the updated rulings of the IRS.
Also, take measures to preserve the stepped-up basis for assets that the trust has passed along to your heirs. This can become tricky quickly, so to protect yourself and be as cautious as possible, it’s wise to work with an estate planning attorney who can help you navigate your situation with confidence.
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