By Attorney Ted Brown
Irrevocable trusts are commonly used to protect assets from the cost of long-term care and to reduce estate tax liability. However, without the right language, an irrevocable trust can create a potentially crippling and unanticipated capital gains tax problem for your heirs.
Capital gains tax applies to the sale of appreciated assets such as land or stocks. In general, the tax is based on the profit that one earns on the sale. The profit is determined by subtracting the value of the property when you acquired it from the sale price. For example, if you buy a piece of land for $100,000 and you sell it for $225,000, you have a capital gain of $125,000. The $100,000 figure is known as your “cost basis.”
A gift or transfer of property during the owner's lifetime to an irrevocable trust will results in a carry-over in the cost basis to the trust, This means that when the beneficiaries eventually sell the assets given to the trust, they will owe capital gains tax on the difference between the sale price and the price that you paid. Depending on how much the property has appreciated over time, this could result in a stifling capital gains tax problem for the beneficiaries years down the road. In order to avoid this, the trust must contain special language that will pull the value of the trust back into the creator's estate and achieving something known as a step-up in basis.
An irrevocable trust is a very complex estate planning tool. It is very important to understand the many nuances of these trusts and of gifting assets before embarking on such a plan. Call us today to learn about how we can develop a customized plan to protect your assets while still preserving tax benefits for your heirs.