Will House in Medicaid Planning Trust Receive Step-up in Basis?
My father created an irrevocable trust of which I am trustee and beneficiary. He put his residence into the trust for Medicaid planning purposes. He has since passed away. Did the residence receive a step-up in basis? Does it matter if he passed away within three years of setting up the trust?
The answer is almost certainly yes for two different reasons. The property will receive the step up if it was in your father’s taxable estate. This does not mean his estate had to pay a tax since with the federal threshold rising to $13 million in 2023, very few estates pay any federal estate tax. (Some states have their own estate taxes with lower thresholds, the lowest being $1 million in Massachusetts and Oregon.)
The first way the property could be in your father’s taxable estate depends on the terms of the irrevocable trust. If your father retained certain rights, such as the right to live in the house, the right to receive any income generated by the trust assets, or the power to change the ultimate beneficiaries of the trust, the property would have been in his taxable estate and received the step-up in basis. On the other hand, if he did not retain any of these rights, the property normally would not be in his estate and the deed into the trust would have been a completed gift at the time of transfer. In that case, it would not have received a step-up based on the terms of the trust.
However, if if the transfer into the trust was a completed gift, there’s an independent factor that may well have brought the property back into your father’s taxable estate with a corresponding step-up in basis. If your father in fact continued to live in the house for the rest of his life, under the Internal Revenue Code (26 U.S. Code § 2036) it would still be included in his estate for tax purposes. The purpose of this provision was to stop taxpayers from avoiding estate taxes by pretending to give away property during their lives but to continue to use and control the property. In other words, if you gave your house to your daughter so she wouldn’t have to pay estate taxes on it when you died, but continued to live in it for the rest of your life, the property would be taxed in your estate even though the deed was in your daughter’s name. Since it would be in your estate, it would receive a step-up in basis.
With the evolution of the tax code, this provision is more protective of taxpayers than it is punitive. Since very few estates pay federal estate taxes, this provision garners them a step-up in basis without a corresponding estate tax. In your father’s case, even if the trust was a completed gift, if he continued to live in the house for the rest of his life, it received a step-up in basis upon his death.
The timing of the transfer does not affect any of these outcomes.