Does an Irrevocable Trust Get a Step-Up in Basis?

An irrevocable trust usually does not get a step-up in basis when the grantor dies. Once you transfer assets into a standard irrevocable trust, the IRS treats the transfer as a completed gift, the assets leave your taxable estate, and the trust inherits your original cost basis instead of a fresh one. The exceptions are narrow but real: an irrevocable trust drafted so that its assets are pulled back into the grantor’s gross estate can still qualify, and that’s a design choice with tax consequences on both sides.

Why the Default Is Carryover Basis

The step-up rule under Section 1014 only applies to property included in a decedent’s gross estate.¹ When you fund a standard irrevocable trust, you permanently give up ownership and control. Because the assets are no longer yours at death, they aren’t part of your gross estate, and Section 1014 doesn’t reach them. Instead, Section 1015 governs: the trust takes a carryover basis equal to whatever you paid.²

Here is what that means in practice. Say you bought property for $200,000, transferred it into an irrevocable trust, and it’s worth $1 million when you die. The trust’s basis stays at $200,000. If the trust sells, the entire $800,000 of appreciation is a taxable gain. If you had held that same property in your own name or in a revocable trust, your heirs would have taken it with a $1 million basis and owed nothing on the built-up appreciation.

People accept this outcome on purpose. Removing assets from your taxable estate is often the whole point, because future appreciation on those assets escapes the 40% federal estate tax.³ For a large enough estate, the estate tax avoided can dwarf the capital gains eventually paid.

When an Irrevocable Trust Does Qualify for a Step-Up

The path to a step-up runs through the estate. If the trust is drafted so that its assets are includible in the grantor’s gross estate under one of the estate tax inclusion rules, Section 1014 applies and the basis resets to fair market value at death. A few provisions do this work.

Retained Life Interest — Section 2036

If the grantor keeps the right to use the property or receive its income for life, the full value of that property comes back into the gross estate.⁴ A qualified personal residence trust where the grantor dies before the term ends is one common example. The home is included in the estate and gets a stepped-up basis.

Power to Alter or Amend — Section 2038

If the grantor holds a power to change who benefits from the trust or how distributions are made, the trust assets are pulled into the gross estate under Section 2038.⁵ The grantor doesn’t have to exercise it; holding it is enough. Releasing the power within three years of death still triggers inclusion.

General Power of Appointment — Section 2041

A general power of appointment gives the holder the ability to direct assets to themselves, their estate, their creditors, or the creditors of their estate. When the power holder dies, those assets are included in their gross estate and qualify for a basis adjustment.⁶ Planners sometimes add a general power of appointment to an existing irrevocable trust for the specific purpose of capturing a step-up.

Grantor Trusts After Revenue Ruling 2023-2

An intentionally defective grantor trust (IDGT) is a common planning tool. The trust is irrevocable and outside the grantor’s estate for estate tax purposes, but a deliberate “defect” in the trust document makes the grantor the owner for income tax purposes, so the grantor pays income tax on the trust’s earnings. That lets the trust grow tax-free while the grantor’s tax payments further reduce their estate.

Many practitioners assumed grantor trust status by itself was enough to produce a step-up at death. Revenue Ruling 2023-2 rejected that view. The IRS ruled that grantor trust treatment for income tax purposes does not, on its own, cause a step-up. The assets must actually be included in the gross estate under Sections 2035 through 2038 or 2041.⁷ If the trust was designed to keep assets out of the estate, the basis after the grantor’s death is the same as the basis before.

For families holding highly appreciated assets in an IDGT, that ruling is a planning trigger. Capturing a step-up now requires modifying the structure — adding a general power of appointment or a retained interest that pulls the assets back into the estate. Doing so revives estate tax exposure, so the choice depends on how big the estate is and how much appreciation is at stake.

The Substitution Power Workaround

One technique survives Revenue Ruling 2023-2 without changing the trust. Many grantor trusts include a power of substitution under Section 675(4)(C), which lets the grantor swap assets of equivalent value in and out of the trust.⁸ This is often the very provision that makes the trust a grantor trust in the first place.

The strategy works like this. Before the grantor expects to die, they exchange low-basis assets held inside the trust for high-basis or cash assets of equal value from their personal holdings. The low-basis assets move into the grantor’s personal estate and receive a step-up at death. The trust now holds cash or high-basis assets that won’t produce a large gain if sold later. The total value hasn’t shifted, because the swap must be for equivalent value, but the appreciated property is now sitting where the step-up can reach it.

Timing is the vulnerability. If the grantor dies before making the swap, the opportunity is gone. And a substitution executed when the grantor is clearly incapacitated invites IRS scrutiny for lack of substance.

Weighing the Step-Up Against Estate Tax

The real question for anyone deciding how to structure an irrevocable trust is whether losing the step-up costs more in capital gains tax than the trust saves in estate tax. That answer depends almost entirely on the size of the estate and how much appreciation the transferred assets carry.

For 2026, the federal estate tax exemption is $15 million per individual and $30 million per married couple. The One Big Beautiful Bill Act, signed in July 2025, made that increased exemption permanent and removed the earlier sunset.³ For estates below that threshold, there is no federal estate tax to avoid, and transferring highly appreciated assets into an irrevocable trust sacrifices the step-up for no federal estate tax benefit.

Consider an estate of $8 million that includes a property bought for $300,000 and now worth $2 million. Moving that property into an irrevocable trust removes it from the estate, but the estate was already under the exemption. The trust now carries a $300,000 carryover basis, and a sale realizes a $1.7 million gain. If the property had stayed in the estate, the heirs would have received a $2 million basis and owed nothing on the appreciation.

For estates that genuinely exceed $15 million, the math flips. The 40% estate tax rate runs roughly twice the top long-term capital gains rate, so accepting carryover basis to keep assets out of the estate often produces the better result. The larger the estate, the more compelling that tradeoff becomes.

Revocable Trusts by Contrast

If you’re comparing structures, a revocable (or living) trust always qualifies for the step-up. You retain full control during your lifetime, so the IRS treats those assets as still belonging to you. They’re included in your gross estate at death, which satisfies Section 1014.¹ For an estate comfortably under $15 million where the goal is basis reset rather than estate tax reduction, a revocable trust delivers that without the tradeoff.

The Step-Down Risk

The basis adjustment goes both directions. If assets included in the gross estate have declined in value since purchase, the basis adjusts down to fair market value at death.¹ That eliminates a built-in loss that could otherwise offset future gains.

Stock bought for $500,000 and worth $200,000 at death takes a $200,000 basis. The $300,000 loss disappears. Assets in a standard irrevocable trust that are outside the estate keep the $500,000 carryover basis, preserving the loss for a later sale. For depreciated assets, keeping them out of the estate can produce a better tax result than pulling them in.

Community Property and the Double Step-Up

Married couples in community property states have an advantage worth knowing about. Under Section 1014(b)(6), when one spouse dies, both halves of community property receive a step-up in basis, not just the decedent’s half.⁹ Transferring community property into an irrevocable trust that removes it from both spouses’ estates gives up that double step-up on the survivor’s half, a benefit that’s difficult to replicate through trust planning.

If the Trust Sells the Asset

One more piece worth planning for: when an irrevocable trust does sell appreciated assets, the tax bite can be steeper than expected. Trusts and estates hit the top 37% federal income tax bracket at just $16,000 of taxable income in 2026.¹⁰ For long-term capital gains, the 20% rate arrives at roughly $16,250, and the 3.8% Net Investment Income Tax applies above $16,000 of adjusted gross income, producing a combined federal rate of 23.8% that an individual beneficiary might not face on the same income.¹¹

Distributing an asset to a beneficiary before sale can sometimes produce a better outcome. The beneficiary carries the same basis but reports the gain on their own return, where the brackets are far more generous. Timing and mechanics need coordination, because a distribution and sale that happen too closely together can look like the trust effectively made the sale.

1
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
2
Office of the Law Revision Counsel. 26 US Code 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
3
Internal Revenue Service. Whats New – Estate and Gift Tax
4
Office of the Law Revision Counsel. 26 USC 2036 – Transfers With Retained Life Estate
5
Office of the Law Revision Counsel. 26 USC 2038 – Revocable Transfers
6
Office of the Law Revision Counsel. 26 USC 2041 – Powers of Appointment
7
Internal Revenue Service. Revenue Ruling 2023-2
8
Office of the Law Revision Counsel. 26 US Code 675 – Administrative Powers
9
Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
10
IRS. 2026 Estimated Tax for Estates and Trusts
11
Internal Revenue Service. Topic No 409 – Capital Gains and Losses