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 automatically together. Step-up in basis depends on whether the property is included in the decedent’s gross estate for federal estate tax purposes (under Internal Revenue Code chapter 11). Medicaid protection depends on the assets being unavailable to the Medicaid applicant. A well-designed Medicaid Asset Protection Trust (MAPT) can satisfy both conditions at once — but a trust that is structured purely to be a completed gift outside the gross estate will protect Medicaid eligibility while losing the step-up. The drafting details control the outcome, and a mistake can cost a family six figures in unnecessary capital gains tax.

By Albert Goodwin, Esq. — New York estate and Medicaid planning attorney, admitted in New York and Florida. Published: October 2024. Last reviewed: February 2025. This article is general legal information, not legal advice for your specific situation.

Why the Question Matters in New York

Two separate bodies of law collide here, and they appear to pull in opposite directions:

• Medicaid protection — Under New York’s estate recovery rules (see NYS Department of Health 11 OHIP/ADM-8), the State can 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 after the five-year look-back period and pass outside the probate estate, shielding them from recovery.
• Step-up in basis — Under IRC § 1014, inherited property generally takes a new income-tax basis equal to its fair market value on the date of death. This new basis only applies to property that is included in the decedent’s gross estate.

The tension is real: Medicaid protection requires the grantor to give up control and access, while gross-estate inclusion (the trigger for step-up) typically requires the grantor to retain some interest. The art of New York Medicaid planning is structuring a trust that gives up enough control to protect the assets but retains just enough of the right interests to keep the property in the gross estate.

What “Step-Up in Basis” Means

The step-up in basis (IRC § 1014) resets the cost basis of inherited property to its fair market value at the date of death, or to the alternate valuation date six months later if the estate elects it. The practical consequences are significant:

• The decedent’s original cost basis — often set decades earlier — is erased.
• Heirs receive the property with a fresh basis equal to its date-of-death value.
• If the heirs sell at or near that value soon after death, little or no capital gains tax results.
• The appreciation that accrued during the decedent’s lifetime escapes capital gains tax entirely.

For a New York City 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

The reason families cannot simply give property away during life is the carryover basis rule (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.
• The recipient bears the full capital gains tax on appreciation that occurred while the donor owned the property.

This is precisely the trap an outright gift — or a poorly drafted irrevocable trust — can spring. Protecting the asset from Medicaid by gifting it away can save Medicaid dollars while costing the family far more in capital gains tax later.

When Property Is Included in the Gross Estate (and Gets Step-Up)

Step-up applies to property included in the decedent’s gross estate under chapter 11 of the Internal Revenue Code. The most relevant inclusion provisions for trust planning are:

• IRC § 2033 — property owned outright at death.
• IRC § 2036 — property transferred during life but with a retained life estate, retained income interest, or a retained right to designate who enjoys the property.
• IRC § 2038 — property transferred with a retained power to alter, amend, revoke, or terminate.
• IRC § 2041 — property over which the decedent held a general power of appointment.
• IRC § 2040 — joint property, to the extent of the decedent’s contribution.
• IRC § 2035 — certain transfers made within three years of death.

For Medicaid trusts, IRC § 2036 is usually the workhorse. It provides that if the grantor transfers property but keeps (1) the right to possess, enjoy, or receive income from the property for life, or (2) the right — alone or with another — to designate who shall possess or enjoy the property or its income, then the entire value of the property is pulled back into the gross estate. Critically, 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 Can Achieve Both Goals

The key is that the interests that cause gross-estate inclusion under § 2036 do not, by themselves, make the assets “available” for Medicaid. A properly drafted irrevocable trust can combine:

• A retained income interest — the grantor receives trust income for life. This triggers § 2036 inclusion. Under 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 a home for life causes that asset to be includable, while keeping it out of the applicant’s countable resources.
• A retained limited (special) power of appointment — the grantor retains the power to redirect who among a class of beneficiaries (typically descendants) ultimately receives the property. A limited power keeps the gift incomplete enough to cause estate inclusion under § 2036(a)(2) without giving the grantor access to principal, so the assets stay protected from Medicaid and creditors.
• Grantor trust status for income tax — so that trust income is taxed to the grantor, and the grantor may use the § 121 capital gains exclusion on a personal residence held in trust.

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

Revenue Ruling 2023-2: The Pitfall to Avoid

In Revenue Ruling 2023-2, the IRS confirmed a point that had long been 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 reasoned that § 1014 step-up requires the property to be “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 practical lesson for New York Medicaid planning is direct and confident: do not rely on grantor-trust status alone to deliver a step-up. The asset must actually be includable in the gross estate through 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 step-up; it disqualifies trusts that were drafted as completed gifts outside the estate. A MAPT designed for § 2036 inclusion remains fully eligible for step-up after this ruling. The takeaway is that 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. By the time of death in 2024 it is worth $1,500,000. The unrealized appreciation is $1,400,000.

• Scenario A — Outright gift / completed-gift trust (no estate inclusion). The children take a carryover basis of $100,000. If they sell for $1,500,000, they have a $1,400,000 capital gain. At a combined federal (20% plus 3.8% net investment income tax) and New York State rate of roughly 30%, the tax bill is on the order of $400,000+.
• Scenario B — Properly drafted MAPT with retained § 2036 interest (estate inclusion). The home is included in the gross estate, so the children receive a stepped-up basis of $1,500,000. A sale at $1,500,000 produces essentially zero capital gains tax.

Both scenarios can protect the home from New York Medicaid estate recovery if the look-back period has run. But 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 can make.

The Alternate Valuation Date

For estates that file 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 all assets in the estate (not selectively) and is only available where it reduces both the gross estate and the estate tax. For most New York Medicaid-planning families — whose estates fall below the federal exemption and do not file an estate tax return — 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 will protect the assets from Medicaid but will not produce a step-up.

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

No. It clarified that completed-gift grantor trusts whose assets are outside the gross estate do not get a step-up. Irrevocable trusts that are deliberately drafted for gross-estate inclusion still receive the step-up.

Does an irrevocable trust avoid New York Medicaid estate recovery?

A properly drafted irrevocable trust keeps the principal out of the Medicaid 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 period 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, transferring into a properly structured trust that retains a § 2036 interest is usually far better than an outright lifetime gift, because the trust can preserve the step-up while still protecting the asset, whereas the outright gift locks in carryover basis.

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

Yes. Reserving a life-use right in the residence is a common technique that both causes gross-estate inclusion (preserving step-up) and keeps the home protected, while letting the grantor continue living there.

Related Reading

• Medicaid Asset Protection Trusts in New York
• Benefits of a Living Trust
• What Assets Can and Cannot Go Into Trusts
• 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, our office can help you coordinate the § 2036 inclusion provisions with New York Medicaid rules. Call 212-233-1233 or email [email protected] to discuss your situation.