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, released in March 2023. The topic came up again after Kiplinger reported on September 26, 2026 that the IRS is inspecting trusts more closely. This affects adult children whose parents bought homes decades ago and parents 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 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 CoreLogic Case-Shiller National Home Price Index reached 336.7 in June 2026, up from a base of 100 in January 2000.

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

Medicaid pays for long-term care after assets are spent down. Federal law sets a 60-month look-back: transfers 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 claim it through estate recovery after death. If 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 included a step-up. A grantor trust is one whose income the IRS taxes to the creator. 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 determines who pays income tax; estate inclusion determines basis treatment.

Go back to the example. 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 gain is measured from $100,000. Federal long-term capital gains rates are 0%, 15%, or 20%. 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.

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. Two common methods:

• 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. If 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 because the federal exemption is $15 million per person in 2026. Whether a retained power maintains Medicaid protection depends on state rules. 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, a 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 excluding the house from the estate suits a family whose primary risk is long-term care costs: modest savings, family history of dementia, and a home with modest appreciation. A trust keeping the house in the estate, or no trust at all, suits a family facing large built-in gains on a home owned for decades.

4 Questions to Ask Before Signing the Deed

1. Find the parent’s original purchase price and improvement records to estimate built-in gain.
2. If a trust 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 requiring 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 is clear: a house excluded from the estate through a completed gift to an irrevocable grantor trust keeps the parent’s original basis. Children owe tax on the full gain at sale. Before signing, confirm with an estate attorney whether the trust keeps the home in the estate.

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