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

Short answer: yes, but only if the trust is drafted correctly. In New York, property held in an irrevocable trust can be protected from Medicaid estate recovery and still receive a step-up in basis at the grantor’s death, but the two results do not happen together automatically. Step-up in basis depends on whether the property is included in the decedent’s gross estate for federal estate tax purposes under chapter 11 of the Internal Revenue Code. Medicaid protection depends on the assets being unavailable to the Medicaid applicant. A well-designed Medicaid Asset Protection Trust (MAPT) satisfies both conditions at once. A trust structured purely as a completed gift outside the gross estate protects Medicaid eligibility while losing the step-up. The drafting controls the outcome, and a mistake can cost a family six figures in unnecessary capital gains tax.

Why the question matters in New York

Two separate bodies of law meet here, and they appear to pull in opposite directions. On the Medicaid side, New York’s estate recovery rules (see NYS Department of Health 11 OHIP/ADM-8) let the State seek recovery from the probate estate of a Medicaid recipient. Assets placed in a properly drafted Medicaid Asset Protection Trust are removed from the applicant’s available resources once the five-year look-back has run, and they pass outside the probate estate, which shields them from recovery.

On the tax side, IRC § 1014 gives inherited property a new income-tax basis equal to its fair market value on the date of death. That new basis applies only to property included in the decedent’s gross estate.

The tension is built in. Medicaid protection requires the grantor to give up control and access, while gross-estate inclusion, the trigger for the step-up, generally requires the grantor to keep some interest. The craft of New York Medicaid planning is a trust that gives up enough control to protect the assets while keeping just enough of the right interests to hold the property in the gross estate.

What the step-up in basis does

The step-up under IRC § 1014 resets the cost basis of inherited property to its fair market value at the date of death, or at the alternate valuation date six months later if the estate elects it. The decedent’s original basis, often set decades earlier, is erased, and the heirs take the property with a fresh basis equal to its date-of-death value. If they sell at or near that value soon after death, little or no capital gains tax results, and the appreciation that accrued during the decedent’s lifetime escapes capital gains tax entirely. For a Manhattan brownstone or a family home in Brooklyn or Queens bought decades ago for a fraction of today’s value, the step-up can be worth more in tax savings than nearly any other planning move.

The carryover-basis trap of lifetime gifts

Families cannot simply give the property away during life because of the carryover basis rule of IRC § 1015. When property is gifted during life, the recipient takes the donor’s original basis. When the recipient later sells, the gain is measured against that old, low basis, and the recipient pays capital gains tax on all the appreciation that occurred while the donor owned the property. That is exactly the trap an outright gift, or a poorly drafted irrevocable trust, can spring: protecting an asset from Medicaid by giving it away can save Medicaid dollars while costing the family far more in capital gains tax later.

When property is in the gross estate and gets the step-up

The step-up applies to property included in the gross estate under chapter 11 of the Code. The inclusion provisions that matter most for trust planning are these.

For Medicaid trusts, § 2036 is usually the workhorse. If the grantor transfers property but keeps either the right to possess, enjoy or receive income from it for life, or the right, alone or with another, to designate who will possess or enjoy the property or its income, the entire value of the property comes back into the gross estate. The inclusion is not limited to the value of the retained life interest; it captures the full fair market value, remainder interest and all (Treas. Reg. § 20.2036-1). Because the whole property is in the gross estate, the whole property gets the date-of-death step-up.

How a New York MAPT achieves both goals

The key is that the interests that cause inclusion under § 2036 do not, by themselves, make the assets “available” for Medicaid. A properly drafted irrevocable trust combines several features.

A retained income interest

The grantor receives the trust income for life, which triggers § 2036 inclusion. Under the Medicaid rules the grantor’s right to income is counted, but the trust principal remains protected and unavailable.

A retained right to live in the residence

Reserving the right to occupy the home for life makes the home includable in the gross estate while keeping it out of the applicant’s countable resources.

A retained limited power of appointment

The grantor keeps the power to redirect which members of a class of beneficiaries, typically descendants, ultimately receive the property. A limited power keeps the gift incomplete enough to cause inclusion under § 2036(a)(2) without giving the grantor access to principal, so the assets stay protected from Medicaid and from creditors.

Grantor trust status for income tax

Trust income is taxed to the grantor, and the grantor can use the § 121 capital gains exclusion on a personal residence held in the trust.

The drafting must remove the grantor’s access to principal, which Medicaid protection requires, while preserving an income interest or limited power of appointment, which the step-up requires. Done correctly, the trust threads the needle. Done carelessly, for example as a clean completed gift with no retained interest, it protects Medicaid eligibility but forfeits the step-up.

Revenue Ruling 2023-2: the pitfall to avoid

In Revenue Ruling 2023-2 the IRS confirmed a point long argued in planning circles: assets held in an irrevocable grantor trust that are a completed gift, and therefore excluded from the grantor’s gross estate, do not receive a step-up in basis at the grantor’s death. The ruling reasons that the § 1014 step-up requires property “acquired from a decedent,” and that grantor-trust status for income tax purposes does not by itself satisfy that requirement. If the property was never in the gross estate, there is no step-up.

The lesson for New York Medicaid planning is direct: do not rely on grantor-trust status alone to deliver a step-up. The asset must actually be includable in the gross estate under a statutory inclusion provision, most commonly a retained income interest or a retained limited power of appointment under § 2036. Revenue Ruling 2023-2 does not disqualify Medicaid trusts from the step-up; it disqualifies trusts drafted as completed gifts outside the estate. A MAPT designed for § 2036 inclusion remains fully eligible for the step-up after the ruling. The drafting choices, not the label on the trust, determine the tax result.

A worked example: the dollars at stake

Consider a New York parent who bought a home in 1985 for $100,000. At death in 2026 it is worth $1,500,000, so the unrealized appreciation is $1,400,000.

Both scenarios can protect the home from New York Medicaid estate recovery once the look-back period has run. Scenario B saves the family roughly $400,000 in capital gains tax purely because of how the trust was drafted. That is the difference a single set of retained-interest provisions makes.

The alternate valuation date

For an estate that files a federal estate tax return, the executor may elect under IRC § 2032 to value assets six months after death rather than on the date of death. The election applies to every asset in the estate, not selectively, and is available only where it reduces both the gross estate and the estate tax. Most New York Medicaid-planning families have estates below the federal exemption and file no estate tax return, so for them the alternate valuation date is generally not available and date-of-death value controls the basis.

Frequently asked questions

Does a Medicaid Asset Protection Trust get a step-up in basis?

It can, but only if the trust is drafted so that the assets are included in the grantor’s gross estate, typically through a retained income interest or a retained limited power of appointment under IRC § 2036. A MAPT that makes a completed gift with no retained interest protects the assets from Medicaid but produces no step-up.

Did Revenue Ruling 2023-2 eliminate the step-up for irrevocable trusts?

No. It clarified that completed-gift grantor trusts whose assets are outside the gross estate get no step-up. Irrevocable trusts deliberately drafted for gross-estate inclusion still receive it.

Does an irrevocable trust avoid New York Medicaid estate recovery?

A properly drafted irrevocable trust keeps the principal out of the applicant’s available resources and out of the probate estate, which is what New York currently reaches for estate recovery. The five-year look-back must pass before the transferred assets are protected for nursing-home Medicaid.

Is it better to gift property during life or transfer it into an irrevocable trust?

For appreciated property, a properly structured trust that retains a § 2036 interest is usually far better than an outright lifetime gift. The trust preserves the step-up while still protecting the asset; the outright gift locks in carryover basis.

Can I keep the right to live in my home if it is in the trust?

Yes. Reserving a life-use right in the residence is a common technique. It causes gross-estate inclusion, which preserves the step-up, keeps the home protected, and lets you go on living there.

Related reading

For more on the tools discussed here, see our pages on Medicaid Asset Protection Trusts in New York, the benefits of a living trust, what assets can and cannot go into trusts, and avoiding probate in New York.

Speak with a New York estate and Medicaid planning attorney

This is one of the most technically demanding intersections in estate planning, and a small drafting error can cost a family hundreds of thousands of dollars in avoidable capital gains tax or lost Medicaid protection. If you are considering a Medicaid Asset Protection Trust, or you are an attorney drafting one, we can help you coordinate the § 2036 inclusion provisions with New York’s Medicaid rules. Call 212-233-1233 or email [email protected] to discuss your situation.