Cost Basis Rules Clarified by IRS

irs tax form paperwork

JGB November 2023 Newsletter

In March of 2023 the Internal Revenue Service made Revenue Ruling 2023-2 clarifying their interpretation of Internal Revenue Code (IRC) § 1014 regarding irrevocable trust basis adjustment at death. This ruling focused specifically on irrevocable grantor trusts commonly referred to as Intentionally Defective Grantor Trusts (IDGT). An IDGT is a type of irrevocable trust that treats the grantor as the trust owner for income tax purposes (they pay the income taxes for the trust during their lifetime), but the assets contributed to the trust (a completed gift for tax purposes) are not included in the gross estate of the grantor at their death. It was previously believed that the use of an IDGT not only removed the trust assets from the decedent’s estate for estate tax purposes but also resulted in a basis adjustment to the fair market value of the trust assets on the decedent’s date of death. Although this was the first time the IRS formally focused on this issue, it is now clear that the IRS will disallow basis adjustment on assets held in an IDGT.

IRC § 1014

Internal Revenue Code § 1014 has been a long-standing tenant of the US tax code, dating back to the early 1930’s where it was formally classified under Section 811, Title 26 of the Internal Revenue Code. Through various iterations over time, IRC § 1014 now provides basis adjustment at death (sometimes also known as a step-up in basis) and can be very effective at reducing capital gain taxes after the death of the property owner. The effectiveness of § 1014 depends on the titling/coordination of the decedent’s assets prior to their death. To receive basis adjustment at death the asset must qualify as part of the decedent’s taxable estate and also qualify as either a bequest, a devise or pass by inheritance.

Basics Of Cost Basis

To further understand basis adjustment at death, we should first explore asset basis treatment during an owner’s lifetime. If person X purchased 50 shares of stock at a price of $10.00 per share, their cost basis is $10.00 per share. If X later sold these shares for

$25.00, they would subtract the original cost basis ($10.00) from the new sales price ($25.00) to establish the taxable capital gain ($15.00) on the stock sale. Simply put, the smaller the variance between the basis and the sales price of an asset, the less capital gains taxes are due from the sale.

If X passed away after their initial stock purchase and named person B as a beneficiary in their Last Will and Testament, B’s new inherited stock basis would be the stock fair market value on X’s date of death. The stock transfer at X’s death qualifies as a bequest under IRC § 1014 and thus qualifies for basis adjustment to the new fair market value at X’s death. If the value of the stock on X’s date of death was $50.00 per share (the new basis) and B later sold the stock for $50.00 per share, no capital gains would be due as a result of the § 1014 stepped-up basis adjustment.

Revocable Living Trust Basis Treatment

If we were to change the example and instead have X owning the stock shares in the name of their Revocable Living Trust (RLT), the same stepped-up basis adjustment would occur at X’s death. Assets titled in the name of X’s RLT qualify for basis adjustment because an asset transfer from a RLT is considered a § 1014 “bequest” and RLT assets are still considered part of X’s taxable estate. It should be noted that basis adjustment does not apply to stocks held within other Qualified Retirement vehicles like Annuities, IRAs or 401(k) accounts.

During RLT administration (after the death of the grantor), it is common for Trustees to liquidate/convert stocks or other capital assets shortly after the death of the grantor. Expediting the liquidation of RLT assets often minimizes capital gain taxes and results in smoother distributions to beneficiaries. Trustees should always consult with their financial advisor, accountant, and attorney before making the decision to quickly liquidate trust assets.

While basis adjustment may seem rather self-evident, appropriately navigating the particular tax nuances often requires a seasoned practitioner. Many people have attempted (and failed) to outwit the IRS on this matter. For example, IRC § 1014(e) specifically denies basis adjustment on property that is gifted during the one-year period prior to the decedent’s death, that is then reacquired by the original individual who transferred the property. In essence, you cannot simply transfer property to a dying person who then leaves it back to the taxpayer/original owner to leverage a basis adjustment to the date of death value.

Do I Have To Changes My Trust?

To be very clear, Revenue Ruling 2023-2 does not impact those utilizing Revocable Living Trusts. The firm has received numerous questions from clients over the last year regarding this Revenue Ruling, and unless you have an Intentionally Defective Grantor Trust as part of your estate plan, you should not be concerned with the Revenue Ruling discussed. With that said, vigilance is still necessary to stay abreast of current and future legal changes likely to impact your estate plan. In just the last few years we have seen two separate legislative adjustments to the treatment of Inherited IRAs (Secure Act and Secure Act 2.0). Furthermore, with the expiration of increased estate tax exclusions contained in the Tax Cuts and Jobs Act, in 2026 we could see a dramatic reduction of the federal estate tax exclusion by more than fifty percent. If you have not taken the time to recently review your estate plan with your respective attorney, there is no time like the present to do so.

TrustGuard™ 2024

TrustGuard™ enrollment for 2024 is now open. TrustGuard™ is a JGB proprietary, process-driven program designed for our clients who are serious about protecting their investment in their Trust-based Estate Plan with an annual review.

A subscription to TrustGuard™ includes: an annual review of your estate plan and trust funding assistance for the enrollment year, any required changes to your plan, access to our exclusive TrustGuard™ quarterly newsletter, and an invitation to our annual TrustGuard™ appreciation event. Clients who are eligible for TrustGuard™ are those who are renewing their TrustGuard™ membership and new clients who executed their trust documents in 2023.

Enrollment for the 2024 TrustGuard™ period ends on February 28, 2024. JGB clients who do not re-enroll during the enrollment period will not have another opportunity to become members of TrustGuard™.

Participation in TrustGuard™ is entirely voluntary. The TrustGuard™ enrollment subscription is billed at an annual flat rate. Clients who pay their enrollment in full prior to February 1, 2024 will receive a $100 discount off of the price of full enrollment. A separate email will be sent with an enrollment form to all eligible TrustGuard™ clients.

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