Understanding how assets are treated upon the death of an individual is crucial for effective estate planning. A key consideration is whether assets owned by a trust receive a step-up in basis at death, significantly impacting tax liabilities for beneficiaries. The step-up in basis adjusts the value of inherited assets to their fair market value at the time of the original owner’s death. This process directly influences financial outcomes for heirs and ensures compliance with tax regulations. Examining the nuances of this adjustment highlights its implications and clarifies the potential benefits or limitations associated with different types of trusts.
Basic Eligibility for Step-Up
Eligibility for a step-up in basis hinges on the relationship between the decedent’s ownership and the trust’s structure. The Internal Revenue Code (IRC) Section 1014 establishes that the basis of property acquired from a decedent is generally the fair market value at the date of death. 1Legal Information Institute. 26 U.S. Code § 1014 – Basis of Property Acquired From a Decedent
Assets in a revocable trust, where the grantor maintains control and can modify or revoke the trust, typically qualify for a step-up in basis because they are considered part of the decedent’s estate for tax purposes. In contrast, irrevocable trusts, where the grantor relinquishes control, may not qualify unless specific conditions are met, such as inclusion in the decedent’s estate under IRC Section 2036. 2Legal Information Institute. 26 U.S. Code § 2036 – Transfers With Retained Life Estate
Types of Trusts That May Qualify
The type of trust significantly affects whether assets are eligible for a step-up in basis. Different structures have distinct tax implications, particularly in terms of how assets are treated at death.
Revocable Arrangements
Revocable trusts, also known as living trusts, are a common estate planning tool due to their flexibility. The grantor can modify or revoke the trust during their lifetime, meaning the assets are part of the grantor’s estate. Under IRC Section 1014, this inclusion allows for a step-up in basis at the grantor’s death, reducing potential capital gains taxes for beneficiaries when they sell inherited assets. For example, if a property purchased for $200,000 appreciates to $500,000 by the grantor’s death, the beneficiaries inherit it with a $500,000 basis, avoiding $300,000 in taxable gains.
Irrevocable Structures
Irrevocable trusts, where the grantor surrenders control over the assets, generally do not receive a step-up in basis unless specific conditions are met. Under IRC Sections 2036 and 2038, if the grantor retains certain powers, such as the right to income or the ability to alter beneficiaries, the assets may be included in the grantor’s estate and qualify for a step-up. Without these conditions, the assets typically do not receive the adjustment, leading to higher capital gains taxes for beneficiaries. Proper structuring of irrevocable trusts is essential to balance tax efficiency with estate planning goals.
Grantor Format
Grantor trusts, a subset of irrevocable trusts, have unique tax implications. The grantor is treated as the owner of the trust’s assets for income tax purposes under IRC Sections 671-679, reporting the trust’s income on their personal tax return. If the trust assets are included in the estate at the grantor’s death, they may qualify for a step-up in basis, similar to revocable trusts. However, the trust’s terms and the grantor’s retained powers must be carefully evaluated to ensure compliance with tax laws and maximize tax benefits for beneficiaries.
Valuing Assets and Confirming Step-Up
Valuing assets for a step-up in basis requires careful attention to detail. The fair market value at the decedent’s death determines tax obligations for beneficiaries. This value is based on factors such as market conditions, asset characteristics, and income potential. For example, real estate appraisals use comparable property sales, while publicly traded securities are valued based on their market price at death.
Confirming the step-up in basis involves aligning the valuation with IRS guidelines. Accurate documentation, including appraisals and expert analyses, is essential to support reported values and avoid penalties during audits. Executors often consult professional appraisers and tax advisors to ensure compliance and accuracy, helping navigate the complexities of valuation and tax regulations.
Reporting Adjusted Basis on Tax Documents
Accurately reporting the adjusted basis of inherited assets is a critical step in estate settlement and tax compliance. Form 706, the United States Estate (and Generation-Skipping Transfer) Tax Return, is used for estates exceeding the federal estate tax basic exclusion amount of $13.99 million for decedents dying in 2025. 3Internal Revenue Service. What’s New — Estate and Gift Tax This return is due within nine months of death, with an automatic six-month extension available by filing Form 4768. 4Internal Revenue Service. Instructions for Form 706
For estates that are required to file an estate tax return, Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, may also be required to report basis information to the IRS and beneficiaries; however, Form 8971 is not required when the estate is below the basic exclusion amount or when Form 706 is filed solely to elect portability. 5Internal Revenue Service. Instructions for Form 8971 and Schedule A