It wasn’t really a secret, but the IRS didn’t make a lot of noise about it either. In March 2023, the agency quietly changed the rules, issuing Revenue Ruling 2023-2 which has a substantial impact on estate planning and irrevocable trusts.

 

In the last 10 years, irrevocable trusts have been used more frequently to protect family assets from being spent down so individuals would qualify for government benefits such as Medicaid and Veterans Administration (VA) Aid and Attendance if they ever needed long-term care.

 

Before the rule change, it was unclear whether assets passing to beneficiaries through an irrevocable trust, in particular property, would receive a step-up in cost basis, eliminating any capital gains taxes. The issue was that the assets in the irrevocable trust were not held by the purchaser of the assets and the assets hadn’t been passed on to the beneficiaries. So, before March 2023, assets transferred from the trust at the death of the grantor were generally given a step-up in basis.

 

Now, the IRS has made the language very precise.  The new ruling says that property held in an irrevocable trust that is not included in the taxable estate at death will not receive a step-up.

 

Why would anyone do irrevocable planning in the first place? It’s driven by an aging population faced with the possibility of needing long-term care that costs on average $6,500-$10,000 a month. Very few families can afford to pay that without using up all their assets. They turn to programs like Medicaid and VA Aid and Attendance to cover the cost. But to qualify, you can only have $2,000 in cash or less. Until the IRS rule change, the irrevocable trust was the only tool available to avoid the spend-down.

 

So, the IRS is now saying that assets held in an irrevocable trust, not included in your estate at death for estate tax purposes, will lose the step-up in basis. In English, it means you’ll lose the step-up in basis if the irrevocable trust isn’t properly set up. What would that look like? Let’s see how it applies to a married couple we’ll call Bill and Sally.

 

Before March 2023

Bill and Sally have a home they bought for $100,000. Now it’s worth $250,000. If they transferred it to an irrevocable trust, the trust could sell the house with a cost basis of $250,000 (not $100,000) and pay no capital gains.

 

After March 2023

Unless the trust is properly worded to ensure that the $100,000 cost basis is included in Bill and Sally’s taxable estate, the heirs will owe capital gains of $150,000.

 

Most families won’t have to worry about estate taxes when the value of their home is included because the current federal estate tax only applies to estates over $12.92 million. That could change when the estate tax is lowered in 2026 to an estimated $5-$7 million.

 

Wording is now key when dealing with taxes and irrevocable trusts. Don’t make the mistake of trying to figure this out on your own. Work with a professional who truly understands what the new IRS Revenue Ruling 2023-2 means and what an irrevocable trust document should say.

 

 

Disclaimer

This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice, or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at info@alhambrapartners.com.