Put Grandma’s House in an Irrevocable Trust to Protect It From the Nursing Home and the Kids Will Lose Their Tax-Free Step-Up. The IRS Ruled on It in 2023

Moving a parent’s house into an irrevocable trust to shield it from nursing home bills can eliminate the children’s capital gains tax step-up at death. The IRS confirmed this in Revenue Ruling 2023-2, issued March 30, 2023, and published in Internal Revenue Bulletin 2023-16. The ruling gained fresh attention after Kiplinger reported on September 26, 2026, that the IRS is scrutinizing irrevocable trust arrangements more closely amid a high-profile Tax Court dispute. This affects adult children whose parents bought homes decades ago, and parents who are considering Medicaid trusts now.

Section 1014 Resets a House’s Tax Cost at Death

Under Section 1014 of the Internal Revenue Code, property inherited at death receives a new cost basis equal to fair market value on the date of death. Basis is the number subtracted from the sale price to calculate taxable gain. If Grandma bought her house for $100,000 and it is worth $500,000 when she dies, the kids inherit a $500,000 basis. Selling near that price triggers little or no federal capital gains tax.

This adjustment is worth more when home prices are high. The S&P Cotality Case-Shiller National Home Price Index (formerly the S&P CoreLogic Case-Shiller index) posted a 1.5% annual gain in June 2026, with the national index level sitting at 336.66, still roughly 3.4 times its January 2000 baseline.

Medicaid’s 60-Month Look-Back Drives the Trust Move

Medicaid pays for long-term care after a person’s assets are spent down. Federal law sets a 60-month look-back period: transfers made during that window before a Medicaid application trigger a penalty period. A home is typically exempt while the owner lives in it, but states can recoup costs through estate recovery after death. When the house enters an irrevocable trust more than five years before care is needed, the state generally cannot reach it. Medicaid rules vary by state.

Revenue Ruling 2023-2 Ended the Grantor Trust Assumption

Many families assumed a grantor trust automatically carried a step-up. A grantor trust is one whose income the IRS taxes to the creator during life. Revenue Ruling 2023-2 addressed completed gifts of assets to irrevocable grantor trusts excluded from the creator’s gross estate. The IRS held that those assets receive no basis adjustment under Section 1014 at death, because they were not acquired or passed from a deceased person as the code defines. Grantor trust status governs who pays income tax; estate inclusion governs basis treatment. The two are separate questions, and confusing them is what caught many estate planners off guard.

The practical cost is significant. If the trust keeps the house out of Grandma’s estate, the kids inherit her original $100,000 basis. When they sell for $500,000, their taxable gain is $400,000. Federal long-term capital gains rates are 0%, 15%, or 20% depending on income. Higher earners also owe the 3.8% net investment income tax, and state income tax may apply on top of that. The children also cannot use the $250,000 home sale exclusion under Section 121 unless they lived in the house themselves.

IRS Scrutiny of Trusts Is Growing

The ruling’s relevance has only grown. As Kiplinger reported in September 2026, the IRS is challenging an irrevocable trust arrangement in a high-profile Tax Court dispute, seeking more than $736 million in gift taxes and penalties. The case centers on how trust assets were moved and substituted, and its outcome could shape how the agency approaches grantor trust structures more broadly. The takeaway for families using Medicaid trusts is straightforward: the IRS has both the legal footing (Revenue Ruling 2023-2) and the stated enforcement interest to scrutinize these arrangements.

Section 2036 Life Estates and Limited Powers Can Keep Both Benefits

How the trust is written determines the outcome. Elder law attorneys often structure Medicaid trusts to keep the house in the taxable estate, preserving the step-up while still providing some protection. Two common methods accomplish this:

• A retained right to live in the home. A reserved life estate or right of occupancy pulls the house back into the estate under Section 2036, which restores the step-up.
• A limited power of appointment. When the parent keeps the power to change which descendants receive the house, the gift is incomplete for gift tax purposes and the home stays in the estate.

Keeping the house in the estate rarely triggers estate tax today. Under the One Big Beautiful Bill Act, the federal exemption rose to $15 million per person in 2026. Whether a retained power also maintains Medicaid protection depends on state rules, and a poorly phrased clause can sacrifice one benefit for the other. This requires an attorney licensed in the parent’s state (most estate messes trace back to a missed form, an outdated beneficiary, or an untitled account, and we put the full cleanup checklist in a free guide here).

Which Approach Fits Which Family

A trust that excludes the house from the estate suits a family whose primary risk is long-term care costs: modest savings, a family history of dementia, and a home with modest built-in appreciation. A trust that keeps the house in the estate, or no trust at all, suits a family facing large built-in gains on a home owned for decades. The right answer turns on the size of the potential capital gains bill versus the realistic exposure to Medicaid estate recovery.

4 Questions to Ask Before Signing the Deed

1. Find the parent’s original purchase price and improvement records to estimate the built-in gain.
2. If a trust already exists, check whether the deed or trust document reserves a life estate, right to live in the home, or limited power of appointment.
3. Ask whether the transfer is a completed gift that requires a Form 709 gift tax return.
4. Ask an estate attorney or CPA whether the house will be included in the gross estate, and whether state law allows modification or decanting if it will not.

Bottom Line on Revenue Ruling 2023-2

Since 2023, the IRS position has been clear: a house excluded from the estate through a completed gift to an irrevocable grantor trust keeps the parent’s original basis. Children owe capital gains tax on the full appreciation at sale. With the IRS now pursuing trust arrangements more aggressively, the stakes of a poorly structured deed transfer have risen. Before signing, confirm with an estate attorney whether the trust keeps the home in the estate.

Editor’s note: This article updates the index name to S&P Cotality Case-Shiller (reflecting Cotality’s acquisition of CoreLogic), adds the June 2026 annual gain figure of 1.5%, includes detail on the IRS’s $736 million Tax Court challenge to irrevocable trust arrangements reported by Kiplinger in September 2026, and notes that the federal estate tax exemption rose to $15 million per person in 2026 under the One Big Beautiful Bill Act.

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