Question:

If my mother transfers real estate into 3 separate nominee trusts and her Irrevocable Trust is the 100% beneficiary of each, does the transfer result in a capital gains tax and a step-up in basis to her beneficiaries? As Donor of the Irrevocable Trust, if she reserves a Limited Power/Special Power of Appointment “exercisable during her lifetime by written instrument to the Trustee to appoint the remaining principal and any undistributed income of the Trust, outright or upon trusts, powers of appointments, conditions or limitations, to members of the class consisting of the donor’s issues of all generations, or charitable organizations other than government entities, but no such power or payment shall be used to discharge a legal obligation of the Donor,” will this cause the property contained in the Irrevocable Trust to be included in the Donor’s estate for tax purposes? Do her beneficiaries of the Trust receive a step-up in basis when they receive the property?

Response:

It sounds like your mother has three separate pieces of property, but that does not mean she needs three separate nominee realty trusts. In fact, given that a single trust will be the beneficiary of all the property, it’s not clear why nominee realty trusts are needed at all. She could simply transfer all three properties directly to the irrevocable trust. But that wasn’t your question.

Whether a transfer to an irrevocable trust is considered a completed gift for tax purposes, thus removing the property transferred from the grantor’s estate, or is an incomplete gift with the transferred property remaining in the grantor’s estate, depends on the terms of the trust. Retaining certain powers can keep the property in the grantor’s taxable estate. Among these, as you suggest, is lifetime power of appointment. A testamentary power of appointment that takes effect at death also does the trick.

Whether the property remains in the grantor’s taxable estate is linked directly to whether the property receives a step-up in basis upon the grantor’s death. If it’s in the estate, it gets a step-up. If it’s not in the grantor’s estate, it does not. In the latter case, the beneficiaries receive the property with a “carry over” basis—the same basis as the grantor had before transferring the property into trust. In your case, the power of appointment language you cite would keep the property in your mother’s taxable estate and it therefore would receive a step-up in basis upon her death.

 

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