Does Property in an Irrevocable Trust Qualify for both Medicaid Protection and Step-Up in Basis?

I’m writing this in October of 2024. There’s been talk about last year’s IRS opinion that disqualified property in some irrevocable trusts from qualifying for a step-up basis after the decedent’s death. https://www.irs.gov/pub/irs-drop/rr-23-02.pdf.

In my opinion, it looks like property can still qualify for a step-up basis, as long as it’s includable in the decedent’s gross estate.

In order to avoid New York Medicaid estate recovery, the trust has to be Irrevocable. https://www.health.ny.gov/health_care/medicaid/publications/adm/11adm8.htm

Chapter 11 of the IRC lists all instances when property is included in the gross estate. https://www.law.cornell.edu/uscode/text/26/subtitle-B/chapter-11/subchapter-A/part-III.

In particular, 26 U.S. Code § 2036 - states that the following property is part of the gross estate: in which the decedent had the right of

(1)the possession or enjoyment of, or the right to the income from, the property (life estate), or

(2)the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.

Looks like that’s life estate or power of appointment. And that it includes the entire property in the gross estate.

the value of the gross estate shall include the value of all property in which the decedent had a life estate, even if it’s in trust. This means that not only the value of the gross estate is included - the value of the entire property is included in the gross estate.

Under 26 U.S.C. § 2036(a), when a decedent has transferred property but retained a life estate—that is, the right to possess or enjoy the property or to receive income from it for life—the entire value of the property is included in the decedent's gross estate for estate tax purposes, not just the value of the retained life estate.

• General Rule of § 2036(a): The statute mandates that if a person transfers property but retains certain interests (like a life estate), the value of the transferred property is brought back into their gross estate upon death.
• Full Inclusion: The law is designed to prevent individuals from avoiding estate taxes by transferring property while retaining the benefits of ownership until death. As such, the full fair market value of the property at the time of death is included in the gross estate.
• Not Limited to Life Estate Value: The inclusion is not limited to the actuarial value of the life interest (the life estate) but encompasses the entire property's value. This means that the remainder interest (the value passing to the beneficiaries after the decedent's death) is also included.

If the decedent retained or reserved an interest or right with respect to all of the property transferred by him, the amount to be included in his gross estate under section 2036 is the value of the entire property, less only the value of any outstanding income interest which is not subject to the decedent's interest (26 CFR § 20.2036-1 (c)), in trust or otherwise (26 CFR § 20.2036-1(a))

Transfers with a retained life estate are includable in the gross estate:

Transfers with retained life estate (section 2036):

Section 2036 applies to the following retained interests or rights.

• The right to income from the transferred property.
• The right to the possession or enjoyment of the property.
• The right, either alone or with any person, to designate the persons who shall receive the income from, possess, or enjoy, the property.

This is a very sensitive area of the law. A small mistake can cost hundreds of thousands of dollars. Before drafting a trust, consult your attorney, and if you are an attorney, you can start with this article and the links above. If you're thinking about making a trust, you can give us a call at 212-233-1233 or send us an email at [email protected].