IRS 2023 Ruling Eliminates Step-Up in Basis for Homes Placed in Irrevocable Trusts

A 2023 IRS ruling confirmed that transferring a home into an irrevocable grantor trust strips beneficiaries of the capital gains tax step-up they would normally receive at death. Families attempting to shield assets from nursing home costs through trusts may inadvertently trigger significant tax liability for heirs, since the new cost basis remains tied to the original purchase price rather than the home's value at death. Keeping a life estate or limited power of appointment within the trust structure can preserve the step-up benefit without triggering estate taxes under current exemption thresholds.

The 2023 IRS ruling clarified a distinction that many estate planners had overlooked: placing property into an irrevocable grantor trust removes it from the taxable estate but simultaneously disqualifies it from receiving a new valuation at death. This matters significantly because home values have appreciated substantially over recent decades. The decision fundamentally altered the tax calculus for families using irrevocable trusts as a Medicaid planning tool, since these arrangements prioritize asset protection from nursing home costs over inheritance tax efficiency.

However, the tax consequence can be mitigated through careful trust design. Incorporating a life estate or limited power of appointment into the trust structure keeps the property within the taxable estate for step-up purposes while still potentially shielding it from Medicaid recovery claims. This approach works under current law because the federal estate tax exemption remains high enough that most families avoid estate taxation, making the step-up preservation the primary benefit.