Step up in basis

[BOB W]

I have read that a step-up in basis cannot happen with an irrevocable trust because the trust does not become part of the T/P estate. Why would people put a house in an irrevocable trust, besides nursing home issues. Lawyers seem to hold a different position on the step-up basis issue of a home sale.

[New York Enrolled Agent]

Read Rev Ruling 2023-2 - maybe that is the source of controversy.

[rjholmes]

Are there circumstances in which the step-up basis would apply in an irrevocable trust? I have read from some posters that there are circumstances, but I have not seen what any of the circumstances would be.

[BOB W]

The only issue that I have heard is when there is wording in the trust that it allows the transfer of assets for cash. Thereby allowing the house to be transferred to personal asset before death. This causes the home to be part of the taxable estate and get a step-up in basis.

[New York Enrolled Agent]

Perhaps a useful article:

Rev. Rul. 2023-2’s impact on estate plans (thetaxadviser.com)

[BOB W]

An existing irrevocable trust would need "court approval" for a change in trust documents to allow reversion of house back to grantor for cash. New irrevocable trust could have that capability built in.

[rjholmes]

Thank you both for the replies. New York Enrolled Agent, thetaxadviser.com is a good read. I am glad that Bob W started this thread. I was about to ask about it myself. I will soon be working on a trust in which a personal residence was purchased by the trust through foreclosure. The attorney says there should not be any tax. I think there will be tax, but I have not yet read the trust document. Once I get all the facts I will go back and reread Rev Ruling 2023-2.

[rjholmes]

In 2012 the taxpayer and his spouse purchased through foreclosure the house in which the spouse's mother lived, giving the mother a life estate.
In 2017 the spouse's mother created a will directing that upon her death the house be sold and a set amount be put into a trust for the great-grandchildren of her late son.
In 2021 the home was put into a newly formed irrevocable trust with taxpayer and spouse as trustees and beneficiaries. They were given control over the trust assets without court intervention. Mother still had life estate.
In 2023 Mom died and the trust sold the home.

From all that I have read, I am thinking that the basis is the costs that the trust incurred when purchasing the house. I have read Rev Ruling 2023-2 several times (thanks again NYEA) and still come to the conclusion that there is no step-up in basis. Do you all agree or disagree?

[BOB W]

In 2012, please explain who owned the foreclosure after it was bought?

[rjholmes]

Bob W, the taxpayer and his wife owned the home after the foreclosure purchase. They are the same ones that were trustees/beneficiaries of the trust, which was formed 9 years later. Between those two transactions, the mom (who had life estate) of the taxpayers made a will regarding the home, which at that time was already in the name of the taxpayer and spouse. The same home 4 years later went into the trust. Mom had life estate throughout the entirety.

[New York Enrolled Agent]

RJ - I think there is an important distinction here to be noted. Based on what you write, the Life Estate was given to mom and not created by mom.

Son and wife gave the life estate interest. During mom’s lifetime she had a life interest in the home but on her death that interest has zero value. There is no interest in the house and thus the house is not part of her estate.

Contrast that with a situation in which mom had owned the home and created a life estate when the deed was changed. In that case, section 2036 would include such home in her estate at FMV on the DOD. Big difference in the two scenarios.

[BOB W]

"In 2017 the spouse's mother created a will directing that upon her death the house be sold and a set amount be put into a trust for the great-grandchildren of her late son."

Mother did not legally own the home to control how the proceeds were to be disbursed.

"In 2021 the home was put into a newly formed irrevocable trust with taxpayer and spouse as trustees and beneficiaries. They were given control over the trust assets without court intervention. Mother still had life estate."

Who was the creator of the trust? Mother? Was she Gifted the home by daughter and husband?

In 2023 Mom died and the trust sold the home.

Per the trust, daughter and spouse are the beneficiary of the trust sale. Cost basis should be the purchase price when paid for in foreclosure.

[rjholmes]

"Per the trust, daughter and spouse are the beneficiary of the trust sale. Cost basis should be the purchase price when paid for in foreclosure."

That was what I thought, but someone else thought there would be no tax at all because of the stepped-up basis. That is why I listed all the steps involved here. I wondered why the mother had included the home in her will after her daughter had purchased it. But it was included in all the papers presented to me and I did not want to miss something. Thanks to you two for your help!

[BOB W]

Sounds like all was done to satisfy Mother's wishes. But needless to say, mother got excluded from her wishes. All now is what the Daughter and Spouse chose to do with Mother's wishes outside any legal ownership, by gifting to great-great grandchildren any stated amount if they want.