April 4, 2023
IRS rules on basis adjustment for assets in grantor trust that were not in decedent's gross estate
The IRS has ruled (Revenue Ruling 2023-2) that a decedent's assets in a grantor trust that were not included in the decedent's gross estate for federal estate tax purposes could not receive a basis adjustment under IRC Section 1014.
The decedent had established an irrevocable trust funded with assets that were a completed gift for gift tax purposes. The decedent retained a power over the trust that caused him to be treated as the owner of the trust for income tax purposes under the grantor trust provisions of IRC Section 671-679 but did not cause the trust to be included in the his gross estate for estate tax purposes. At the time of the decedent's death, the fair market value (FMV) of the trust assets had appreciated. The trust's liabilities did not exceed the basis of its assets and neither the trust nor the individual held a note on which the other was the obligor.
Law and analysis
IRC Section 1041(a)(1) generally considers the basis of property that was acquired from or passed from a decedent to a person, if not sold, exchanged, or otherwise disposed of before the decedent's death by that person, to be the FMV of the property at the date of the decedent's death.
Under IRC Section 1014(b), seven types of property are considered to have been acquired from or to have passed from the decedent for purposes of IRC Section 1014(a), including: (1) property acquired by bequest, devise or inheritance, or by the decedent's estate from the decedent; (2) property where a decedent had, while alive, the power to (a) revoke or (b) amend the trust or hold a power to appoint the assets; (3) property transferred under a testamentary general power of appointment; (4) community property; (5) property that is included in a decedent's gross estate under the provisions of Chapter 11; and (6) property included in a surviving spouse's estate due to a marital deduction allowed in the first-to-die spouse's estate.
The IRS first found that the assets were not "bequeathed," "devised" or "inherited" within the meaning of IRC Section 1014(b)(1) when the decedent died. The IRS based its analysis on previous case law and legislative history and found that the property transferred in trust before the decedent's death was not bequeathed or inherited because it did not pass either by will or intestacy.
The IRS then found that the assets did not fall within any of the remaining types of property listed in IRC Section 1014(b).
The IRS concluded that the assets in the grantor trust could not receive a basis adjustment because: (1) property must be acquired or passed from a decedent under IRC Section 1014(a) to receive a basis adjustment; (2) the property must fall within one of the seven types listed in IRC Section 1014(b) for IRC Section 1014(a) to apply; and (3) the assets did not fall within any of the seven types of property listed in IRC Section 1014(b). As a result, IRC Section 1014(a) does not apply, and the basis of the assets immediately after the decedent's death is the same as the basis of assets immediately preceding the decedent's death.
This matter has been on the IRS priority guidance plan since 2015. Many practitioners believe that IRC Section 1014(b) applies to preclude a basis adjustment for property that is includible in a decedent's estate for estate tax purposes. However, a few practitioners take the position that assets in a "defective grantor trust" (i.e., a trust that is not includible in a decedent's estate) receive a basis step-up under IRS Section 1014(b)(9)(C). The argument likely stems from PLR 201245006, which was issued by the IRS in 2012 and addressed the application of IRC Section 1014 to foreign grantor trusts.
Because the taxpayer held the power to appoint the trust property via will or deed at death, the IRS concluded in the PLR that the property was received by taxpayer's heirs via bequest, devise or inheritance under IRC Section 1014(b)(1). As such, the IRC Section 1014(b)(9(C) exception was met, and the property would receive a basis step-up even though it was not includible in the decedent's US taxable estate.
In light of this PLR, a few practitioners have argued that assets received on account of a decedent's death, even if not included in the decedent's gross estate, are eligible for an IRC Section 1014(a) basis adjustment. For a defective grantor trust, the argument is that, if the assets passing under the inter vivos trust are deemed to constitute a bequest, as they appear to have been in the PLR, then the basis in any irrevocable grantor trust should be adjusted under IRC Section 1014(a). Revenue Ruling 2023-2 closes the door on this argument by clarifying that assets in a defective grantor trust are generally not assets eligible for an IRC Section 1014(a) basis adjustment because they are not acquired or passed from a decedent within the meaning of IRC Section 1014(b).
Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor