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  • Writer's pictureSteven J. Rosenthal, CPA, CFP, JD

New Capital Gains and Estate Tax Planning Challenges with Grantor Trusts

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Estate planners have relied on a technique that allows heirs to receive a “stepped-up basis” in assets inherited from certain grantor trusts. If the property inherited from the trust has appreciated in value over time, planners have taken the position that the tax basis of the inherited property is “stepped-up” to fair market value at the time of the grantor’s death. Consequently, when the heir sells the asset, the capital gains tax will be minimized.

For example, if an inherited stock has appreciated in value from $1,000 during the life of the grantor to $10,000 at the grantor’s death, the heir can sell the asset for $10,000 and pay no capital gains tax. Without the step-up, the heir will pay tax on a $9,000 gain.

“Intentionally defective” irrevocable grantor trusts have been used for the dual purpose of managing estate tax liabilities while ensuring that beneficiaries of those trusts will acquire assets on a stepped-up basis. However, the use of intentionally defective trusts has been called into question by Internal Revenue Service Revenue Ruling 2023-2. The ruling provided that assets in a defective grantor trust are not eligible for a stepped-up basis because they are not considered to be acquired or passed from a decedent within the meaning of the Internal Revenue Code.

This ruling creates a unique tax planning challenge in Washington State for large estates that might have assets denied a step-up in basis on the federal level. On one hand, an intentionally defective grantor trust may be used to avoid Washington estate taxes, but on the other hand, that same trust may saddle an heir with a potential Washington Capital Gains Tax if the inherited asset bases will generate capital gains above the $250,000 tax exclusion threshold when sold.

Fulcrum Advisors can help clients plan around existing IRS and Washington tax rules to minimize future estate and capital gains taxes. For further reading, see the following:

Investment advisor representative of securities and investment advisory services offered through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker/dealer, and Registered Investment Advisor. Cetera is under separate ownership from any other named entity. In addition, some Investment advisory services are offered through Fulcrum Wealth Advisors, LLC. Fulcrum Wealth Advisors, LLC is a registered investment advisor in the State of Washington. Branch Address: 10940 NE 33rd PL., #210 Bellevue, WA 98004 Branch Phone: 877-400-0260

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice. The views stated in this letter are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed.

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