IRS rules trust property not included in estate is not eligible for basis adjustment

In detail 

The Ruling examines whether there is a basis adjustment under Section 1014 for the assets of a trust on the death of the individual who is the income tax owner of the trust if the trust assets are not includible in the owner’s gross estate. Based on the fact that the trust assets were not includable in the owner’s gross estate, the Ruling concludes that the assets do not receive a step up (or down) in basis, rather, the assets retain the same basis as just before the owner’s death. 

An individual established an irrevocable trust and funded it with an asset in a transfer that was a completed gift for gift tax purposes. The individual retained a power over the trust that caused the individual to be treated as the owner of the trust for income tax purposes, but would not result in the inclusion of the trust’s assets in the individual’s gross estate. At the time of the individual’s death, the trust assets had appreciated. 

Section 1014(a)(1) generally provides that the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent, if not sold, exchanged, or otherwise disposed of before the decedent’s death by that person, is the fair market value of the property at the date of the decedent’s death. This is generally referred to as a “stepped up (or down) basis,” meaning the basis of the asset is stepped up or down to fair market value. Section 1014(b) lists seven types of property that qualify for this stepped up basis, including “[p]roperty acquired by bequest, devise, or inheritance, or by the decedent’s estate from the decedent.”

The Ruling concludes that the property held by the trust does not qualify for any of the seven property types listed under Section 1014(b). The Ruling looks to Black’s Law Dictionary for support. Specifically, the Ruling indicates that “a ‘bequest’ is the act of giving property (usually personal property or money) by will,” a “‘devise’ is the act of giving property, especially real property, by will” and “an ‘inheritance’” is property received from an ancestor under the laws of intestacy or property that a person receives by bequest or devise.” Additionally, the owner did not retain a power to revoke or amend the trust or hold a power to appoint the property; the property was not community property. 

Note that the Ruling specifically indicated that the liabilities of the deceased owner’s trust did not exceed the basis of the assets held by the trust and that neither the trust nor the owner held a note on which the other was the obligor.

Observation: Although taking a position that assets in a “defective” grantor trust (a trust that  is grantor for income tax purposes but not included for estate tax purposes) would obtain a basis adjustment at death may not have been common, there had been commentary about this issue and guidance was expected for some time, as indicated above. This Ruling should not change tax treatment for most taxpayers.