No Basis Step-Up for Grantor Trust Not in Grantor’s Estate

An irrevocable grantor trust can be used for a variety of personal and tax reasons. The grantor is taxable on the income from the trust during his or her life. Upon death, the assets of the trust become the property of the beneficiary or beneficiaries. Importantly, the assets under certain trust language may not be considered as acquired or passed from the decedent by bequest, devise, or inheritance. The IRS, after waiting too long in the opinion of many tax experts, has made it clear that if the assets of the trust are not includible in the grantor’s taxable gross estate when he or she dies, there is no stepped-up basis for those assets (Rev. Rul. 2023-2). Lifetime income tax liability for the trust’s income is not dispositive. The IRS presented this example:

An individual (the grantor) set up an irrevocable trust funded with certain assets and treated as a completed gift for gift tax purposes. However, because the grantor retained a lifetime power over the trust, the grantor is treated as the owner of the trust for income tax purposes. The power, however, does not cause the trust to be included in the grantor’s gross estate. When the grantor died 7 years after establishing the trust, the assets had appreciated. The beneficiary of the trust cannot use a stepped-up basis for the assets that have been inherited through the trust because the trust was not included in the grantor’s estate.