This article is not tax advice and the discussion herein is oversimplified to relay the concept of step-up in basis. Your individual situation should be reviewed by your attorney and tax professional. Show There has been a lot of discussion in Congress about what, if anything, should be done with the income tax code to address step-up in basis. Step-up in basis is a concept that affects beneficiaries who liquidate the assets of a person who passes away (“Decedent”). Not many people know or understand what step-up in basis is, but the proposal to eliminate step-up in basis should concern anyone who is doing an estate plan and has capital assets. The concept of step-up in basis is actually quite simple. A trust or estate and its beneficiaries, or payable on death beneficiaries, get a step-up in basis to fair market value of the asset so received. That value is stepped up to the fair market value of the asset as of the date of death of the Decedent. This is true even if the beneficiary of the asset so transferred is a spouse of the Decedent. To break that down, if Dad owns a piece of property that is worth $500,000 and he paid $100,000 for the property, he has a tax basis of $100,000 for the home. If Dad sells the property during his lifetime, he would pay taxes on the gain in the difference between what he paid for the property ($100,000) and what he sold it for ($500,000). So, he would have income of $400,000. Under the current tax law, if he held that asset for more than one year, the gain would be treated as a capital gain. Now, if Dad passes away and leaves the property to me, I would get a step-up in basis, as of the date of Dad’s death, to fair market value. If I now go and sell the property for $500,000, I have zero gain on the sale. My basis was “stepped up” to the value of the asset as of the date of death. Take an asset that the Decedent has depreciated. Dad owns a 4-family apartment building that he bought for $1,000,000; $250,000 of that purchase was attributable to land and $750,000 was attributed to the building. Over 40 years, Dad depreciated the building so that building now has no depreciation left. Depreciation is a book entry allowed by the IRS that allows you to deduct the “loss” of the value over time. At the time of acquiring the property, the depreciation was 37.5 years, or in our case $20,000 per year ($750,000/37.5 = $20,000). If the property is now worth $2,000,000 and Dad wants to sell it during his lifetime, he would have a basis of $250,000 and a taxable gain of $1,750,000, or the $2,000,000 less the basis of $250,000. Now, if I inherit that same property after Dad passes away and I sell it for $2,000,000, I would recognize no taxable gain because I get a “stepped up” basis to the fair market value of $2,000,000. If I hold onto the property, I can begin a new depreciation based on the new value. As mentioned above, spouses of Decedents also get a step-up in basis when their wife or husband passes away. Why is this important? Let’s say you are a married couple in your 80s and you are working on your estate plan. You are deciding what to sell and what to keep. Certainly, you want to sell assets that have a high basis to minimize your income taxes. And, you want to hold assets with a low basis to allow the survivor of you to have a full step-up in basis to fair market value on one of you passing away. In short, if the step-up in basis is eliminated, beneficiaries receiving assets will have to pay full income tax on assets received where they generally do not have to under the current tax code. Axley Brynelson is pleased to provide articles, legal alerts, and videos for informational purposes, but we are not giving legal advice or creating an attorney/client relationship by providing this information. The law constantly changes, and our publications may not be currently updated. Before relying on any legal information of a general nature, please consult legal counsel as to your particular situation. While our attorneys welcome your comments and questions, keep in mind that any information you provide us, unless you are now a client, will not be confidential.
Photo by Mel Elías on Unsplash Question:If my mother transfers real estate into 3 separate nominee trusts and her Irrevocable Trust is the 100% beneficiary of each, does the transfer result in a capital gains tax and a step-up in basis to her beneficiaries? As Donor of the Irrevocable Trust, if she reserves a Limited Power/Special Power of Appointment “exercisable during her lifetime by written instrument to the Trustee to appoint the remaining principal and any undistributed income of the Trust, outright or upon trusts, powers of appointments, conditions or limitations, to members of the class consisting of the donor’s issues of all generations, or charitable organizations other than government entities, but no such power or payment shall be used to discharge a legal obligation of the Donor,” will this cause the property contained in the Irrevocable Trust to be included in the Donor’s estate for tax purposes? Do her beneficiaries of the Trust receive a step-up in basis when they receive the property? Response:It sounds like your mother has three separate pieces of property, but that does not mean she needs three separate nominee realty trusts. In fact, given that a single trust will be the beneficiary of all the property, it’s not clear why nominee realty trusts are needed at all. She could simply transfer all three properties directly to the irrevocable trust. But that wasn’t your question. Whether a transfer to an irrevocable trust is considered a completed gift for tax purposes, thus removing the property transferred from the grantor’s estate, or is an incomplete gift with the transferred property remaining in the grantor’s estate, depends on the terms of the trust. Retaining certain powers can keep the property in the grantor’s taxable estate. Among these, as you suggest, is lifetime power of appointment. A testamentary power of appointment that takes effect at death also does the trick. Whether the property remains in the grantor’s taxable estate is linked directly to whether the property receives a step-up in basis upon the grantor’s death. If it’s in the estate, it gets a step-up. If it’s not in the grantor’s estate, it does not. In the latter case, the beneficiaries receive the property with a “carry over” basis—the same basis as the grantor had before transferring the property into trust. In your case, the power of appointment language you cite would keep the property in your mother’s taxable estate and it therefore would receive a step-up in basis upon her death. Related Articles:What are the Tax Implications of Owning Property in Nominee Realty Trusts?What are the Tax Consequences if I Transfer Real Estate into Trust?Can Property in a Medicaid-Planning Trust Get a Step-Up in Basis Upon the Grantor’s Death?What’s a “Step-Up” in Basis and Why Would You Want It?Don’t know how your trust works?Whether you’re creating a plan, managing a trust, or are a beneficiary of a trust, this book is your easy-to-read roadmap. Discover the book →  Do irrevocable trusts get a step up?Irrevocable Trusts
The trust assets will carry over the grantor's adjusted basis, rather than get a step-up at death. Assets held in an irrevocable trust that has its own tax identification number (i.e., nongrantor trust status) do not receive a new basis when the grantor dies.
Does stepped up basis apply to trusts?A trust or estate and its beneficiaries, or payable on death beneficiaries, get a step-up in basis to fair market value of the asset so received. That value is stepped up to the fair market value of the asset as of the date of death of the Decedent.
Are distributions from an irrevocable trust taxable to the beneficiary?Irrevocable trust: If a trust is not a grantor trust, it is considered a separate taxpayer. Taxable income retained by the trust is taxed to the trust. Distributed income is taxed to the beneficiary who receives it.
Who pays capital gains tax in an irrevocable trust?One fundamental tax-focused decision when structuring a trust is whether the trust should be a grantor trust or a non-grantor trust. If the former, the grantor will be responsible for paying the income tax on income (including capital gains) produced by the trust assets. If the latter, the trust will pay its own taxes.
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Do beneficiaries of irrevocable trust get stepped up basis
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