Does a Grantor Trust Get a Step-Up in Basis at Death?

Whether a grantor trust gets a step-up in basis at death depends on the type of trust. A revocable grantor trust receives a full step-up because its assets are pulled into the grantor’s gross estate at death. An irrevocable grantor trust that has been structured to sit outside the gross estate generally does not — the beneficiaries take the grantor’s original cost basis instead.

Why Estate Inclusion Is the Real Test

Federal law resets the basis of property received from a decedent to its fair market value on the date of death.¹ The step-up erases any appreciation that built up during the decedent’s lifetime for capital gains purposes. Inherited stock a parent bought for $50,000 that was worth $300,000 at death takes a new basis of $300,000; a sale at that price the next day produces no taxable gain.

The catch is in the definition. Property qualifies only if it was “acquired from a decedent,” which in practice means it has to be included in the decedent’s gross estate for federal estate tax purposes.² Property that stays outside the gross estate keeps its original cost basis. That single rule drives everything that follows.

The adjustment cuts both ways. If an asset dropped in value before death, the basis steps down. The pre-death loss cannot be recovered when the heir sells.

Revocable Grantor Trusts: Full Step-Up

A revocable grantor trust, often called a living trust, lets the grantor amend or revoke it at any time. Because the grantor never truly surrenders control, the trust assets are treated as part of the gross estate at death. The estate tax rules reach any transfer where the grantor kept the right to alter, amend, or revoke,³ and separately any transfer where the grantor retained the right to possess, use, enjoy, or direct the property.⁴

Because the assets are in the gross estate, they qualify for the basis reset.¹ Every asset inside — real estate, stocks, business interests — takes a new basis equal to its fair market value on the date of death.

Irrevocable Grantor Trusts: Generally No Step-Up

Irrevocable grantor trusts are the harder case. Many are structured as “intentionally defective” grantor trusts (IDGTs), where the grantor keeps paying income tax on the trust’s earnings but the assets sit outside the gross estate. The income-tax and estate-tax treatments are mismatched on purpose. The grantor absorbs the annual tax bill while the trust grows free of eventual estate tax.

The IRS confirmed in Revenue Ruling 2023-2 that this mismatch runs in both directions. If the trust assets are not included in the grantor’s gross estate, they do not receive a basis adjustment at death.⁵ The property was not acquired from a decedent within the meaning of the statute, so the basis carries over unchanged. Beneficiaries inherit whatever the grantor’s basis was.

The ruling prevents a double benefit: dodging both estate tax and capital gains tax on decades of appreciation. If a grantor moved stock worth $100,000 into an IDGT and it grew to $1 million by death, the beneficiaries’ basis is still $100,000. Selling at $1 million produces $900,000 of taxable gain.

The Swap Power Workaround

Grantors can often work around this result if they plan early enough. Many irrevocable grantor trusts include a power of substitution, which lets the grantor swap personal assets for trust assets of equal value.⁶ That same power is what causes many of these trusts to be treated as grantor trusts for income tax purposes to begin with.

The strategy is straightforward. If the trust holds a low-basis, highly appreciated asset, the grantor exchanges it out of the trust for cash or other high-basis property of equal value. The low-basis asset now sits in the grantor’s personal name, will be included in the gross estate at death, and gets the step-up. The high-basis property remaining in the trust does not need one because there is little built-in gain to reset.

Timing is the risk. The swap must happen while the grantor is alive and competent, and the replacement property must genuinely be worth what it replaces. If the grantor dies or loses capacity first, the low-basis assets stay stuck in the trust with their original basis intact.

Married Couples in Community Property States

Married couples who hold community property through a grantor trust get an unusually favorable result. When one spouse dies, the entire value of the community property — both halves — is stepped up to fair market value, provided at least half was includible in the deceased spouse’s gross estate.¹ The surviving spouse can sell the whole asset the next day with no capital gains tax on marital appreciation.

The community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.⁷ In every other state, only the deceased spouse’s share of jointly held property steps up. If a couple in a common-law state bought property for $200,000 that was worth $600,000 when the first spouse died, the survivor’s new basis is $400,000, not $600,000: $100,000 original basis on the surviving half plus a $300,000 stepped-up basis on the inherited half.

Assets That Never Step Up

Some assets do not receive a basis reset regardless of what type of trust holds them. The main category is “income in respect of a decedent” — income the decedent had earned or become entitled to but had not yet been taxed on. The step-up statute explicitly excludes these items.¹

Traditional IRAs and 401(k)s. Distributions are taxed as ordinary income to the beneficiary; no step-up erases that.
Annuities. Payments to a surviving beneficiary under a joint-and-survivor contract are treated as income in respect of the decedent to the extent they would have been taxable to the original annuitant.⁸
Installment obligations. Remaining gain built into future payments passes through to the heir as taxable income.
Unpaid compensation and deferred income. Bonuses, commissions, and earned but unpaid amounts stay taxable when collected.

If a grantor trust is funded mainly with retirement accounts or annuities, the step-up rules will not reduce the income tax bill the beneficiaries eventually face on those assets.

Establishing and Reporting the New Basis

For assets that do qualify, the beneficiary needs documentation of fair market value on the date of death. Publicly traded securities are valued at the average of the highest and lowest selling prices that day.⁹ Real estate requires a written appraisal from a qualified appraiser. Private business interests need a certified valuation from a credentialed professional.

When the beneficiary later sells, the gain or loss is calculated from the stepped-up basis. Report the sale on Form 8949 and carry the totals to Schedule D.¹⁰

If the estate had to file Form 706, the executor also files Form 8971 and provides each beneficiary a Schedule A showing the value of the property they received.¹¹ A beneficiary’s basis cannot exceed the value reported on the estate tax return; reporting a higher basis on your own return exposes you to a 20-percent accuracy-related penalty on any underpayment.¹ Keep the Schedule A you receive; it is the number you have to use.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
eCFR. 26 CFR 1.1014-1 – Basis of Property Acquired From a Decedent
3
Office of the Law Revision Counsel. 26 USC 2038 – Revocable Transfers
4
eCFR. 26 CFR 20.2036-1 – Transfers With Retained Life Estate
5
Internal Revenue Service. Revenue Ruling 2023-2
6
Office of the Law Revision Counsel. 26 USC 675 – Administrative Powers
7
Internal Revenue Service. Publication 555 (12/2024), Community Property
8
Office of the Law Revision Counsel. 26 USC 691 – Recipients of Income in Respect of Decedents
9
eCFR. 26 CFR 20.2031-2 – Valuation of Stocks and Bonds
10
Internal Revenue Service. About Form 8949, Sales and Other Dispositions of Capital Assets
11
Internal Revenue Service. Instructions for Form 8971 and Schedule A