Want to Leave Assets to Heirs? IRS Rule Change Should Have You Rethinking Your Irrevocable Trust

If you’ve set up an irrevocable trust, or are thinking about creating one, it may be time to take a closer look. Recent IRS rule changes surrounding estate and gift tax exemptions could significantly affect how much wealth you’re able to pass on to your heirs. For years, irrevocable trusts have been a go-to strategy for high-net-worth families looking to protect assets and reduce taxes. However, with new regulations on the horizon, what once made perfect sense for your estate plan might now require a second look. Understanding how these changes impact you can help ensure your legacy stays protected and your wealth transfers efficiently to the next generation.

If you need help interpreting the IRS rule change or setting up your estate, consider speaking with a financial advisor.

What Is a Step-Up in Basis?

When someone inherits an asset with unrealized capital gains, the basis of the asset resets or “steps up,” to the current fair market value, wiping out any tax liability for the previously unrealized capital gains.

For example, if you purchased stock for $100,000 more than a year ago and sold it now for $250,000, you would pay capital gains tax on the $150,000 profit above the original basis of $100,000. If you inherit that stock, however, your new basis steps up to $250,000 and you’ll pay tax only if you sell the stock for more than that amount.

To protect their assets, many people place them in an irrevocable trust, which means they lose all ownership rights to the assets. Instead, the trust becomes the owner of the assets for the benefit of the trust’s beneficiaries.

How IRS Rule Change Impacts Irrevocable Trusts

Previously, the IRS granted the step-up in basis for assets in an irrevocable trust but the new ruling – Rev. Rul. 2023-2 – changes that. Unless the assets are included in the taxable estate of the original owner (or “grantor”), the basis doesn’t reset. To get the step-up in basis, the assets in the irrevocable trust now must be included in the taxable estate at the time of the grantor’s death.

That’s the bad news. The good news is that because of the $12.92 million per-person exclusion in 2023 ($25.84 million for married couples), few estates in the United States pay even a portion of the estate tax.

In 2021, 6,158 estates were required to file estate tax returns, with just 2,584 of them (42%) paying any tax at all. By including the irrevocable trust assets in the taxable estate, heirs who are the beneficiaries of the trust will dodge the tax hit and receive the step-up in basis. However, that situation could change for some people in 2026 when the estate tax exemption limit reverts to the 2017 amount of $5 million, adjusted for inflation.

Why would someone be using an irrevocable trust? A typical reason is to remove assets from your ownership in order to qualify for Medicaid nursing home assistance. A parent could place a home worth $500,000 into the trust, qualify for Medicaid but, by including the home in their taxable estate, then pass the property on to their children tax-free at a basis of $500,000.

How to Know if an Irrevocable Trust is Right For You

An irrevocable trust can be a powerful estate planning tool, allowing you to transfer assets out of your taxable estate, protect them from creditors, and provide a structured way to pass wealth to your heirs. Once established, however, the terms of the trust generally can’t be changed without the beneficiaries’ consent or a court order. This makes it important to fully understand what you’re giving up, primarily control over the assets, in exchange for potential tax and legal benefits.

Before creating an irrevocable trust, think carefully about your long-term financial objectives. If your priority is to minimize estate taxes or protect assets from future liabilities, this type of trust can be effective. But if you anticipate needing access to the funds for personal use (such as medical expenses, retirement income or emergencies) then a more flexible arrangement like a revocable trust or gifting strategy may be better suited.

An irrevocable trust offers strong protection and potential tax savings, but it also limits flexibility. It’s best suited for individuals with substantial estates who are certain about how they want their assets managed and distributed. For those who value control and flexibility, other estate planning tools may achieve similar goals with fewer restrictions.

Bottom Line

Woman discusses her estate plan with her daughter, son-in-law and grandchildren.

Anyone using an irrevocable trust should be reviewing their estate plan to make sure it complies with the updated IRS rule and preserve the step-up in basis for assets that the trust will pass on to their heirs. Building a sufficient estate plan is also something that most people should try to have in place in order to limit issues for their family down the road.

Financial Planning Tips

A financial advisor can help you make sense of important rule changes so your financial plan stays on track. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Life insurance can play a vital role in the financial planning process so that your loved ones are protected in the event that something happens to you. SmartAsset has a life insurance tool specifically designed to help you determine how much coverage you need.