No Stepped-Up Basis for Trust Assets That Were Not Included in Gross Estate

(Parker Tax Publishing April 2023)

The IRS ruled that the step-up basis adjustment under Code Sec. 1014 does not apply to the assets of an irrevocable grantor trust not included in the deceased grantor's gross estate for estate tax purposes. According to the IRS, even though the grantor trust's owner is liable for income tax on the trust's income, the assets of the grantor trust are not considered as acquired or passed from a decedent by bequest, devise, inheritance, or otherwise within the meaning of Code Sec. 1014(b) and therefore, Code Sec. 1014(a) does not apply. Rev. Rul. 2023-2.

Background

In Rev. Rul. 2023-2, the IRS addressed whether there was a basis adjustment under Code Sec. 1014 to the assets of the trust on the death of the individual who was the owner of the trust, where the trust assets were not includable in the owner's gross estate.

The facts were as follows. In Year 1, a taxpayer established irrevocable trust and funded the trust with an asset in a transfer that was a completed gift for gift tax purposes. The taxpayer retained a power over the trust that caused the taxpayer to be treated as the owner of the trust for income tax purposes. The taxpayer did not hold a power over the trust that would result in the inclusion of the trust's assets in the decedent's gross estate. By the time of the taxpayer's death in Year 7, the fair market value (FMV) of the asset in the trust had appreciated. At the taxpayer's death, the liabilities of the trust did not exceed the basis of the assets in the trust, and neither the trust nor the taxpayer held a note on which the other was the obligor.

Under Code Sec. 671, if the grantor or another person is treated as the owner of any portion of a trust, the taxable income and credits of the grantor or the other person include those items of income, deductions, and credits of the trust that are attributable to that portion of the trust to the extent that these items would be taken into account under in computing taxable income or credits of an individual.

Code Sec. 1012(a) provides that the basis of property is generally its cost, except as otherwise provided in the Code. One exception is set forth in Code Sec. 1014. Under Code Sec. 1014(a)(1), the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent, if not sold, exchanged, or otherwise disposed of before the decedent's death by that person, is the fair market value (FMV) of the property at the date of the decedent's death. Code Sec. 1014(b) lists the seven types of property that are considered to have been acquired from or to have passed from the decedent for purposes of Code Sec. 1014(a). Under Code Sec. 1014(b)(1), property is treated as having been acquired from or to have passed from a decedent if the property was acquired by bequest, devise, or inheritance, or by decedent's estate from the decedent.

Reg. Sec. 1.1014-1(a) generally provides that the basis of property acquired from a decedent is equal to its value for estate tax purposes. Accordingly, generally the basis of property acquired from a decedent is the FMV of such property at the date of the decedent's death. Property acquired from a decedent includes, principally, property acquired by bequest, devise, or inheritance, and, in the case of decedents dying after December 31, 1953, property required to be included in determining the value of the decedent's gross estate under any provision of the Internal Revenue Code of 1954 or the 1939 Code.

Reg. Sec. 1.1014-2(a)(1) provides that property acquired by bequest, devise, or inheritance, or by the decedent's estate from the decedent, whether the property was acquired under the decedent's will or under the law governing the descent and distribution of the property of decedents, is considered to have been acquired from a decedent and the property's basis is determined under the general rule in Reg. Sec. 1.1014-1. Reg. Sec. 1.1014-2(b)(2) generally provides that property is considered to have been acquired from a decedent to the extent such property is includible in the decedent's gross estate if the decedent died after December 31, 1953.

In Rev. Rul. 84-139, D, a citizen and resident of a foreign country, died owning real property located in the foreign country. B, a United States citizen, inherited the real property. Because the property was located outside the United States and D was a nonresident alien, the value of the property was not includible in D's gross estate under Code Sec. 2103. B sold the property the following year and claimed the asset's FMV as its basis. The ruling concluded that, because B inherited the property, and the property was within the definition of property acquired from a decedent under Code Sec. 1014(b)(1), it received a basis adjustment to FMV at D's death. In Rev. Rul. 84-139, which did not involve a grantor trust, the property at issue was acquired by a bequest.

Analysis

The IRS ruled that, under the facts presented, the basis of the asset was not adjusted to its FMV on the date of the taxpayer's death under Code Sec. 1014 because the asset was not acquired or passed from a decedent as defined in Code Sec. 1014(b). Accordingly, the asset's basis immediately after the taxpayer's death is the same as the basis of the asset immediately prior to the taxpayer's death.

The IRS explained that, for property to receive a basis adjustment under Code Sec. 1014(a), the property must be acquired or passed from a decedent. For property to be acquired or passed from a decedent for purposes of Code Sec. 1014(a), it must fall within one of the seven types of property listed in Code Sec. 1014(b). However, according to the IRS, under the facts presented the asset did not fall within any of the seven types of property listed in Code Sec. 1014(b).

First, the IRS found that upon the taxpayer's death, the asset was not bequeathed, devised, or inherited within the meaning of Code Sec. 1014(b)(1). According to the IRS, a bequest is the act of giving property (usually personal property or money) by will. Likewise, a devise is the act of giving property, especially real property, by will. In addition, an inheritance is defined as property received from an ancestor under the laws of intestacy or property that a person receives by bequest or devise. The IRS noted that in Bacciocco v. U.S., 286 F.2d 551 (6th Cir. 1961), the court found that property transferred in trust prior to the decedent's death was not bequeathed or inherited because it did not pass either by will or intestacy. The court construed the terms "bequest" and "inheritance" according to their usual and normal meaning and noted that the decedent's death did not transfer the assets to the trust. In the view of the IRS, this did not imply that property in a trust could never fall within the meaning of Code Sec. 1014 (such as property including in the decedent's gross estate or property specifically described by Code Sec. 1014(b)(2), (3), or (4); however, the IRS found that in the facts outlined above, the trust property did not fall within the meaning of those terms.

The IRS found that the asset did not fall within any of the remaining types of property listed in Code Sec. 1014(b). The asset was not described in Code Sec. 1014(b)(2), (3), or (4) because the taxpayer did not retain a power to revoke or amend the trust or hold a power to appoint the asset. The asset also was also not described by Code Sec. 1014(b)(6) because it was not community property. Finally, the asset was not described by Code Sec. 1014(b)(9) or (10) because it was not included in the taxpayer's gross estate.

For a discussion of the basis of property acquired from a decedent, see Parker Tax ¶110,530.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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