Revenue Ruling 2023-2: Why Certain Irrevocable Trusts No Longer Receive a Step-Up in Basis at Death

Irrevocable trusts have become a cornerstone of modern estate and long-term care planning. Families use them to protect assets from creditors, reduce estate taxes, preserve wealth for future generations, and—most commonly in later-life planning—to help manage eligibility for Medicaid long-term care benefits and avoid forced “spend-down” scenarios. In a cross-border context, irrevocable trusts are commonly used by those moving to Canada to keep taxable investment assets in the U.S., avoid Canadian trust taxation, and the deemed disposition upon death.

However, a critical tax assumption underlying many irrevocable trust strategies has changed.

In Revenue Ruling 2023-2, the IRS clarified that assets held in certain irrevocable grantor trusts do not receive a step-up in basis at the grantor’s death when those assets are not included in the grantor’s gross estate. This ruling has significant implications for estate planning, trust design, and long-term care strategies going forward.

This article explains what changed, how planning used to work, how it works now, and what families and advisors should consider next

What Is a Step-Up in Basis?

When an individual dies, many assets they own receive a step-up in cost basis under Internal Revenue Code §1014. This means the asset’s tax cost basis is adjusted to its fair market value as of the date of death.

The practical result is powerful:

• Lifetime appreciation is erased for income tax purposes
• Heirs can often sell inherited assets shortly after death with little or no capital gains tax
• Step-up in basis is often more valuable than estate tax savings for anyone who is under, or near, the estate tax exemption amount, which is $15,000,000 per person in 2026.

But the step-up in basis is not automatic. It applies primarily to property “acquired from a decedent,” which generally means property included in the decedent’s taxable estate.

How Irrevocable Trust Planning Commonly Worked Before Revenue Ruling 2023-2

Many irrevocable trusts are drafted as grantor trusts for income tax purposes. While the trust is legally separate, the grantor remains responsible for paying the trust’s income taxes during life.

Over time, a widespread planning assumption emerged:

If the trust is a grantor trust and the grantor pays the income tax, the trust assets should receive a step-up in basis at the grantor’s death.

This assumption became particularly common in:

• Medicaid asset-protection trusts
• Irrevocable trusts used to remove assets from the taxable estate
• Trusts designed to shelter assets from creditors while preserving income tax efficiency

In many cases, planners believed they could achieve both:

1. Removal of assets from the estate, and
2. A full step-up in basis at death

Revenue Ruling 2023-2 directly challenges that belief.

What Revenue Ruling 2023-2 Actually Says

Revenue Ruling 2023-2 addresses a specific, but very common fact pattern:

• A grantor transfers appreciated assets to an irrevocable trust
• The transfer is a completed gift for estate and gift tax purposes
• The trust is a grantor trust for income tax purposes
• The retained powers that cause grantor trust status do not cause estate inclusion
• The grantor dies

IRS Conclusion

If the trust assets are not included in the grantor’s gross estate, those assets do not qualify for a step-up in basis under §1014, even though the trust was treated as a grantor trust during life.

In short:

Grantor trust status alone does not create a step-up in basis.
Estate inclusion matters.

The trust assets retain their carryover basis, and any unrealized appreciation remains subject to capital gains tax when sold by the trust or beneficiaries.

Why This Matters for Medicaid and Long-Term Care Trust Planning

Most asset-protection trusts used for long-term care planning are intentionally designed so that:

• The grantor does not have unrestricted access to principal
• The assets are not treated as “available resources” for Medicaid eligibility (subject to look-back, repayment, and penalty rules)
• The assets are excluded from the grantor’s taxable estate

These goals may still be achieved, but Revenue Ruling 2023-2 makes the tradeoff explicit.

The New Reality

If an irrevocable trust is designed to:

• Protect assets from spend-down rules, and
• Keep those assets outside the taxable estate

Then it is increasingly likely that:

• Those assets will not receive a step-up in basis at death

This creates a planning tension between:

• Asset protection and eligibility planning, and
• Income tax efficiency for heirs

How Irrevocable Trust Planning Works Now

After Revenue Ruling 2023-2, trust planning should explicitly analyze:

1. Will the trust assets be included in the grantor’s estate?
2. If not, is the loss of step-up in basis acceptable?
3. Which assets are being placed into the trust?
4. Who is expected to ultimately bear the capital gains tax?

Asset selection now matters more than ever. Low-basis, highly appreciated assets may be poor candidates for certain irrevocable trusts, depending on family goals. On the other hand, holding assets with high appreciation potential is often appropriate for irrevocable trusts.

Planning Considerations Going Forward

Asset Location Strategy

Planners may increasingly separate:

• High-appreciation assets intended for step-up, and
• Assets intended primarily for protection or eligibility planning

Basis Management Techniques

In appropriate cases, planners may explore:

• Asset substitution powers
• Strategic lifetime sales
• Trust restructuring or decanting (where permitted by state law)

Each option carries legal, tax, and compliance considerations and must be evaluated carefully.

Intentional Estate Inclusion

In some families, it may be advantageous to intentionally include certain trust assets in the taxable estate to preserve a step-up in basis, particularly where estate tax exposure is unlikely.

Future Changes on the Horizon

Step-up in basis remains a frequent topic in federal tax policy discussions. Proposed changes over recent years have included:

• Limiting step-up for higher-income households
• Treating death as a realization event
• Increasing capital gains tax rates

At the same time, estate tax exemptions remain historically high, shifting planning priorities toward income tax efficiency rather than estate tax minimization for many families.

Revenue Ruling 2023-2 fits squarely into this evolving environment and reinforces the need for proactive, integrated planning.

Key Takeaway

Revenue Ruling 2023-2 does not eliminate the usefulness of irrevocable trusts but it does eliminate a common assumption.

If assets are intentionally excluded from the estate, they may also be excluded from the step-up in basis.

Modern estate and long-term care planning must now balance:

• Asset protection
• Eligibility rules
• Estate tax exposure
• Capital gains consequences

Ignoring any one of these factors can undermine the entire plan.

Educational Disclaimer

This article is for general educational purposes only and does not constitute legal or tax advice. Trust taxation, Medicaid eligibility, and estate inclusion rules are highly fact-specific and vary by jurisdiction. Consult qualified legal and tax professionals before implementing or modifying any trust strategy.