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The Impact of Revenue Ruling 2023-2 on Estate Planning: Why Accurate Valuations Matter More Than Ever

By Brian A. Sullivan, CPA/ABV

Revenue Ruling 2023-2 has significantly reshaped the estate planning landscape, particularly for professionals who rely on intentionally defective grantor trusts (IDGTs) as a wealth transfer strategy. The IRS has clarified that assets transferred to an IDGT will not receive a step-up in basis at the grantor’s death unless those assets are included in the grantor’s gross estate for federal estate tax purposes. This marks a critical shift, eliminating a commonly relied-upon planning benefit and forcing advisors to reconsider long-standing strategies.

In the past, estate planners often used IDGTs to remove appreciating assets from a client’s taxable estate while still anticipating a step-up in basis at death due to the trust’s grantor status for income tax purposes. Under the new ruling, that expectation is no longer valid. If the assets are not included in the estate, they retain their original carryover basis. As a result, beneficiaries may face substantial capital gains taxes when those assets are eventually sold, creating outcomes that can be both unexpected and financially burdensome.

The implications of this ruling are best illustrated through real-world scenarios. Consider a taxpayer who transferred highly appreciated stock with a low basis into an IDGT, expecting heirs to receive a step-up in basis at death. If those heirs later sell the asset, they may discover that the IRS requires them to use the original basis rather than the fair market value at death, resulting in a significant taxable gain. In many cases, this could translate into millions of dollars in additional tax liability that could have been avoided under prior assumptions.

Several commonly used estate planning techniques are directly impacted by this change. For example, selling assets to an IDGT in exchange for a promissory note has long been a popular strategy. While the transaction remains effective for removing appreciation from the estate, it no longer provides the dual benefit of a basis step-up unless the asset is brought back into the estate before death. Similarly, simply holding appreciated assets within an IDGT without planning for estate inclusion can now lead to unfavorable tax consequences for beneficiaries.

One of the most concerning outcomes is the potential for double taxation. In certain scenarios, the promissory note received in exchange for the asset may be included in the estate and subject to estate tax, while the underlying asset remains in the trust without a basis adjustment. When the asset is eventually sold, the beneficiaries must recognize capital gains based on the original basis. This combination of estate tax and capital gains tax can produce a worse result than if the asset had been retained until death and received a full step-up in basis.

The ruling also creates challenges for depreciated assets. If an asset transferred to an IDGT declines in value, the loss may effectively be trapped within the trust. Because the asset is not included in the estate, it does not receive a step-down in basis, and the opportunity for beneficiaries to recognize a tax loss is lost. Additionally, transactions occurring shortly before death may fail to achieve intended tax outcomes, leaving assets outside the estate without a basis adjustment and exposing heirs to immediate tax consequences.

Another layer of complexity arises when assets are encumbered by debt. In situations where liabilities exceed an asset’s basis, no gain is recognized at the time of inheritance, and the beneficiary typically receives a basis equal to the fair market value if the asset is included in the estate. However, when the asset is later sold, the amount realized includes both the sale proceeds and any debt assumed by the buyer. This can result in unexpectedly large taxable gains, even when the property’s equity appears limited.

Given these developments, accurate valuations have become more important than ever. The value assigned to assets for estate tax purposes directly determines the beneficiary’s income tax basis. Under current IRS rules, these values must be consistent across filings, and discrepancies can trigger audits, penalties, and additional tax liabilities. With increased IRS scrutiny, well-documented and defensible valuations are now essential for both compliance and effective tax planning.

The penalties for valuation errors can be severe. Substantial misstatements may result in a 20 percent penalty, while gross misstatements can trigger penalties of up to 40 percent. Additional penalties may apply for negligence or disregard of IRS rules, and appraisers themselves may face financial consequences for inaccurate valuations. These risks underscore the importance of engaging qualified professionals and maintaining thorough documentation.

To adapt to the new environment, estate planners and advisors should take proactive steps. Existing estate plans should be carefully reviewed to identify IDGTs holding low-basis assets. Where appropriate, planners may consider using substitution powers to bring those assets back into the estate to secure a step-up in basis. Coordination between spouses is also critical to ensure that assets are positioned to receive basis adjustments at the appropriate time. In many cases, it may now be more advantageous to retain highly appreciated assets until death rather than transferring them during life.

For taxpayers who previously received advice that is no longer consistent with Revenue Ruling 2023-2, immediate action may be necessary. Advisors should review prior filings, assess potential exposure, and determine whether amended returns are required. Clear documentation and transparent communication with clients are essential to mitigate risks and maintain trust. Updating internal processes and staying informed on evolving IRS guidance will also help ensure that future planning remains compliant and effective.

In conclusion, Revenue Ruling 2023-2 represents a fundamental shift in estate planning strategy. The long-standing assumption that grantor trust status alone could produce a step-up in basis has been definitively rejected. As a result, the relationship between estate inclusion and income tax basis has taken center stage in planning decisions. Accurate valuations, thoughtful structuring, and proactive review of existing plans are now critical to achieving optimal tax outcomes and avoiding costly surprises for both estates and their beneficiaries.

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