For many homeowners and investors, understanding how to preserve the basis adjustment for assets, like a home or portfolio, is essential for future tax planning and protecting family wealth. As a result of recent IRS announcements, many people are worried that they’ll lose this benefit if they place their home or other assets into a trust.
In this article, I’ll clarify how putting assets into a trust—whether revocable or irrevocable—affects the basis adjustment at the time of transfer. By the end, you’ll understand which types of trusts can retain the basis adjustment, even if the assets are placed into a trust, and what strategies may help you protect your hard-earned wealth.
What is Basis Adjustment and Why Is It Important?
The “basis” of an asset is essentially its value for tax purposes. The key to preserving wealth when passing assets down to the next generation is the “basis adjustment,” or step-up in basis. When someone passes away, certain assets may receive a new basis—usually set at the current market value on the date of death. This adjustment can save thousands, if not millions, in capital gains taxes for heirs.
For example:
- Let’s say you bought your home decades ago for $100,000, and today it’s worth $700,000.
- If you sold it during your lifetime, the difference ($600,000) would likely be subject to capital gains tax.
- However, if the home passes through your estate at your death, the basis adjusts to its market value on that date, allowing your heirs to avoid a major capital gains tax burden if they choose to sell it.
The New IRS Rules: How They Affect Basis Adjustment for Trusts
The New IRS Rules: How They Affect Basis Adjustment for Trusts
In recent guidance, the IRS clarified that if you put assets into an irrevocable trust that is not included in your taxable estate, those assets will lose the basis adjustment benefit. This rule is often misunderstood, and people now fear that all assets placed in a trust, including revocable trusts or estate-included irrevocable trusts, will lose the basis adjustment. Let’s break down how this works.
Revocable Trusts vs. Irrevocable Trusts: How They Affect Basis Adjustment
Revocable Trusts: Basis Adjustment Is Retained
A revocable trust, also known as a living trust, allows the creator (or grantor) to retain control over the assets. Because the grantor retains control and the assets are still technically part of their taxable estate, assets in a revocable trust *do* receive the basis adjustment at death.
In other words, if you place your home into a revocable trust, your heirs will likely still enjoy a step-up in basis upon your passing, preserving the same capital gains tax benefits they would have received if the home was held outside of a trust.
Irrevocable Trusts: Basis Adjustment Depends on Estate Inclusion
Irrevocable trusts, on the other hand, are a bit more complex. Once you place assets into an irrevocable trust, you generally cannot amend or revoke the trust. Assets in a “traditional” irrevocable trust are removed from your estate, which is beneficial if you aim to reduce estate tax exposure. However, these assets do *not* receive a basis adjustment upon death if they are not included in your estate for tax purposes.
The good news is that certain types of irrevocable trusts can be drafted to include assets in your taxable estate, meaning your beneficiaries could still receive a basis adjustment. These are commonly known as “grantor trusts” or “intentionally defective grantor trusts” (IDGTs) and allow for specific provisions to ensure the asset basis adjusts at your death.
Example: Irrevocable Trust with Estate Inclusion
Let’s say John owns a vacation property purchased for $200,000, now worth $1 million. He wants to protect it from future creditors and reduce the risk of losing it if long-term care becomes a factor, so he places it into an irrevocable trust. However, John still wants his heirs to receive a basis adjustment. By setting up the trust as a grantor trust and including specific language to ensure estate inclusion, John can achieve asset protection and preserve the basis adjustment benefit.
Common Misconceptions About Basis Adjustment and Trusts
Misconception #1: Assets in All Trusts Lose Basis Adjustment
Many believe that any asset placed in a trust will lose its basis adjustment, but this isn’t true. Only assets in certain irrevocable trusts, where estate inclusion is not desired, will forfeit the basis adjustment. Assets in revocable trusts and certain irrevocable trusts can still receive this adjustment.
Misconception #2: Irrevocable Trusts Are All the Same
People often assume all irrevocable trusts function the same way. In fact, there are many types, each serving different purposes with unique tax and asset protection implications. Working with an estate planning professional is essential to determine which trust best suits your goals.
Why Basis Adjustment Matters: Protecting Your Family’s Wealth
Preserving the basis adjustment is a significant benefit for family wealth, especially when planning to pass down a valuable home or other assets to children. Without this benefit, your heirs could face a substantial tax burden if they choose to sell the asset. Here’s how proper planning can help:
Example: Tax Savings with Basis Adjustment
Imagine Sarah places her $500,000 home into a revocable trust. Upon her passing, the home’s value is $800,000. Because the trust is revocable, her heirs receive a step-up in basis, meaning the basis adjusts to $800,000. If they sell it immediately, they avoid capital gains taxes.
Had she used an irrevocable trust without estate inclusion, her heirs could face taxes on a $300,000 gain, significantly reducing the inheritance.
Why Work with an Estate Planning Professional?
If you’re uncertain about how to structure your estate, you’re not alone. Misconceptions about basis adjustment and trust structures are common, and IRS rules continue to evolve. By working with an estate planning professional, you’ll gain insights into how different trusts function and how to preserve tax benefits for your heirs.
Here’s how a professional estate plan can safeguard your legacy:
1. Avoid Guardianship and Conservatorship: Avoid the public court process and make it simple for your loved ones to manage your affairs if you’re incapacitated.
2. Minimize Probate: Streamline the process for passing on your assets and avoid costly, lengthy court procedures.
3. Save on Taxes and Expenses: Ensure your assets are structured for maximum tax efficiency, especially when it comes to capital gains.
4. Protect Your Heirs from Life’s Unexpected Events: Shield the assets you leave behind from potential risks like divorce, lawsuits, or poor money management.
If you’re ready to take the next step in protecting your home and assets for your loved ones, contact us today at either our Minnetonka, MN office at (763) 420-5087 or our Florida office at (941) 909-4644. You can also fill out the contact form on this page, and a team member will reach out to schedule your consultation.
Or, if you’re not ready to schedule a consultation but have additional questions, here are some resources for you:
