Revenue Ruling 2023-2 tells you that assets held in an irrevocable grantor trust do not get a basis step-up when the grantor dies, as long as those assets sit outside the grantor’s taxable estate.1Internal Revenue Service. Revenue Ruling 2023-2 For the beneficiaries who eventually sell that property, the practical result is a carryover basis and a capital gains bill measured against the grantor’s original purchase price, not the value on the date of death.
What the Ruling Actually Held
The IRS worked through a clean fact pattern: a grantor creates an irrevocable trust, retains a power that makes it a grantor trust for income tax purposes, funds it with a completed gift, and structures things so the trust assets never enter the gross estate. Does Section 1014 give those assets a stepped-up basis at the grantor’s death? The ruling says no.1Internal Revenue Service. Revenue Ruling 2023-2
The statutory hook is the phrase “acquired from a decedent.” Section 1014’s step-up requires the property to fit that definition, and the definition turns on either passing through a will, being held in a revocable trust, or being included in the gross estate.2Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent Assets placed in an irrevocable trust and deliberately kept out of the estate meet none of those tests. The grantor’s death does not convert a completed lifetime gift into a testamentary transfer.1Internal Revenue Service. Revenue Ruling 2023-2
The ruling rejects an argument some planners had pressed for years: that because grantor trusts are treated as owned by the grantor for income tax purposes, the assets should be treated as owned by the grantor for basis purposes at death. The IRS drew a firm line. Income tax ownership and estate tax ownership are separate concepts, and only estate tax inclusion triggers a basis step-up.
The Ruling Reaches Back to Older Trusts
Revenue Ruling 2023-2 appeared in Internal Revenue Bulletin 2023-16. Standard IRS policy is that published rulings apply retroactively unless the ruling says otherwise, and this one contains no prospective-only language.3Internal Revenue Service. Internal Revenue Bulletin 2023-16 Irrevocable grantor trusts created long before 2023 fall under the same analysis. If a grantor died in 2020 and the trust’s assets were not in the gross estate, the IRS position is that no step-up was available then either.
Some tax practitioners have argued the ruling misreads the statute and predicted a court challenge. As of 2026, no reported court decision has directly tested the holding. Until one does, the ruling is the operative rule for taxpayers and preparers.
Why This Happens: The Split Personality of a Grantor Trust
An irrevocable grantor trust sits in two places in the tax code at once. For income tax, the grantor is treated as owning the assets, and all income, deductions, and credits flow to the grantor’s personal return.4Office of the Law Revision Counsel. 26 USC 671 – Trust Income, Deductions, and Credits Attributable to Grantors and Others as Substantial Owners For estate tax, the grantor owns nothing, because the whole point of the irrevocable structure is to move wealth outside the taxable estate.
Grantor trust status is usually triggered by retaining a limited administrative power, such as the ability to swap trust assets for personal assets of equal value.5Office of the Law Revision Counsel. 26 USC 675 – Administrative Powers Those powers pull the income tax back to the grantor without pulling the property back into the gross estate. The gross estate only picks up property where the decedent held specific rights at death, such as a retained income interest, the power to revoke, or the power to change beneficiaries.6Office of the Law Revision Counsel. 26 USC 2036 – Transfers With Retained Life Estate
Before the ruling, some planners treated this dual status as the best of both worlds: estate tax savings while alive, plus a stepped-up basis at death. Revenue Ruling 2023-2 shuts that door. If the trust is outside the estate, the beneficiaries take the grantor’s original basis, the same rule that governs any other completed gift.7Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust
What Carryover Basis Costs Your Beneficiaries
Without a step-up, beneficiaries inherit the grantor’s original cost basis. If the grantor bought real estate for $200,000, funded the trust with it, and the property is worth $1,000,000 when the grantor dies, the beneficiary’s basis is $200,000. A sale for $1,000,000 produces $800,000 of taxable capital gain.1Internal Revenue Service. Revenue Ruling 2023-2
Long-term capital gains for 2026 run at 0%, 15%, or 20% depending on the seller’s overall taxable income. The 15% rate applies to taxable income above $49,450 for single filers and above $98,900 for married joint filers, and the 20% rate begins above $545,500 for single filers and $613,700 for joint filers.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill On an $800,000 gain, a beneficiary in the top bracket owes $160,000 in federal capital gains tax before any state tax.
The 3.8% net investment income tax adds another layer. It applies once modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers, and those thresholds are not adjusted for inflation.9Office of the Law Revision Counsel. 26 USC 1411 – Net Investment Income Tax A beneficiary already above the threshold faces a combined federal rate of up to 23.8% on the sale.
If the trust itself sells the asset and keeps the proceeds, the math gets worse. Estates and trusts hit the 3.8% surtax at just $16,000 of adjusted gross income in 2026, so gains reported on the trust’s return are taxed at the highest combined rate on nearly every dollar of gain.10Internal Revenue Service. Schedule D (Form 1041) – Capital Gains and Losses
One partial offset: if the grantor paid gift tax when funding the trust, the beneficiary can increase the carryover basis by the portion of that tax attributable to the net appreciation of the gift.7Office of the Law Revision Counsel. 26 USC 1015 – Basis of Property Acquired by Gifts and Transfers in Trust Most trusts funded within the lifetime exemption paid no gift tax, so this adjustment usually gives nothing, but it’s worth calculating for transfers that exceeded the exemption.
The Substitution Swap: The Main Workaround
The most practical fix is already sitting inside many irrevocable grantor trusts: the power of substitution. That power lets the grantor reacquire trust assets by swapping in other property of equal value, and it is one of the most common provisions used to establish grantor trust status in the first place.5Office of the Law Revision Counsel. 26 USC 675 – Administrative Powers
The move is straightforward. The grantor swaps high-basis assets, such as cash or recently purchased securities, into the trust and takes back the low-basis appreciated assets. The trust now holds high-basis property, so beneficiaries face minimal capital gains if they later sell. The grantor now personally owns the appreciated property, and because it’s in the grantor’s estate at death, it qualifies for a full basis step-up under Section 1014.
The swap itself is not a taxable event. Because the grantor and the grantor trust are treated as the same taxpayer for income tax purposes, moving assets between them is not a sale. Revenue Ruling 85-13 established that treatment and remains good law. The trustee has a fiduciary duty to confirm the swapped assets are of equivalent value, but if that condition is met, the exchange triggers no gain or loss.
The catch is timing. The grantor has to be alive and competent to exercise the power. Waiting until the grantor is terminally ill or incapacitated may be too late. For families with existing irrevocable grantor trusts holding highly appreciated property, executing the swap while the grantor is healthy is the cleanest way to neutralize the carryover basis problem.
Other Ways to Get the Step-Up Back
Design for Estate Inclusion
Revenue Ruling 2023-2 only applies when trust assets are excluded from the gross estate. Assets that are included get the step-up. A trust can be structured, or in some cases decanted, so that the grantor retains a power that triggers inclusion under Section 2036, such as a right to income or the power to change beneficiaries.6Office of the Law Revision Counsel. 26 USC 2036 – Transfers With Retained Life Estate The trade-off is that the assets are then subject to estate tax, but with a $15 million individual exemption in 2026, many estates absorb the inclusion without owing any estate tax while still capturing the step-up.
Incomplete Gift Non-Grantor Trusts
An incomplete gift non-grantor trust, sometimes called an ING trust, runs the trade-off the other way. The grantor retains enough power that the transfer is treated as an incomplete gift, so the assets stay in the gross estate. Because the trust is a non-grantor trust, income is taxed at the trust level rather than on the grantor’s return. At death, the assets are included in the estate and receive a full basis step-up. The cost is the loss of the income tax advantages of a grantor trust.
Sell Inside the Trust Before Death
If a swap is not practical and the trust holds highly appreciated property, selling while the trust is still a grantor trust is worth considering. The gain is reported on the grantor’s personal return, where the effective rate is often lower than what the beneficiary or the trust itself would pay after death, particularly given the compressed trust tax brackets. The proceeds then sit in the trust with a fresh, high basis.
Why the 2026 Exemption Changes the Calculation
The federal estate tax exemption for 2026 is $15,000,000 per individual, up from $13,990,000 in 2025, after the One Big Beautiful Bill permanently raised the base amount.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill A married couple using portability can shelter up to $30,000,000 combined.11Internal Revenue Service. What’s New – Estate and Gift Tax
That level reframes the entire trade-off. Many families set up irrevocable grantor trusts years ago to escape an estate tax that no longer threatens them. For those families, keeping the assets inside the taxable estate now costs nothing in estate tax and preserves the basis step-up. The irrevocable trust that once saved estate tax may be costing beneficiaries far more in capital gains than it would ever have saved. That shift is what makes the swap, and the other structural fixes, worth acting on rather than filing away.
Get the Basis Records in Order Now
Once the step-up is off the table, the grantor’s original purchase price and any capital improvements become the foundation of every future tax calculation. Beneficiaries will need records that may be decades old: closing statements from real estate purchases, brokerage confirmations, receipts for improvements, and records of any gift tax paid when the trust was funded. If those records are lost, the IRS can treat the basis as zero, which makes the entire sale price taxable gain.
Trustees should assemble and maintain basis documentation as a routine part of trust administration, especially for trusts funded with assets that have appreciated significantly over the grantor’s lifetime. Getting the basis right is the difference between a defensible return and one that either overpays or invites an audit.