JEST / joint revocable trust basis planning

The goal is a basis result that couples in community property states already get for free. Section 1014 resets the basis of property included in a decedent’s gross estate to its value on the date of death, which erases the unrealized gain that built up during life. In the nine community property states, a special rule gives both halves of the community a new basis at the first spouse’s death, not just the half the deceased spouse owned. In the other forty-one states a jointly held asset usually gets only half an adjustment, because only half of it is pulled into the first estate. A joint exempt step-up trust, shortened by planners to JEST, is a joint revocable trust an attorney drafts to reach the community property answer in a common law state. Both spouses put property into one trust. The document then gives the first spouse to die a power over the share the survivor contributed that is broad enough to pull that share into the deceased spouse’s gross estate, which is what opens the door to a new basis on the whole pool rather than half of it. The basis rules behind all of this are set out in Publication 551.

Numbers show the size of the prize. Take a couple in Ohio holding a rental portfolio bought for 1,000,000 dollars that is now worth 4,000,000 dollars and titled jointly. If the husband dies first under ordinary rules, only his half is included in his estate, so the survivor’s basis becomes 2,500,000 dollars, half old cost and half date of death value. Pull the entire portfolio into his estate instead and the basis becomes 4,000,000 dollars. That extra 1,500,000 dollars of basis is worth roughly 357,000 dollars of avoided federal tax if the widow sells soon afterward at 4,000,000 dollars, using a 23.8 percent combined rate, with the sale reported on Form 8949 and carried to Schedule D. If she keeps the buildings rather than selling, the added basis restarts depreciation on the improved portion and can throw off something like 40,000 dollars a year of fresh deductions against the rent.

Any JEST joint revocable trust basis planning conversation starts with where the couple lives and what their assets originally cost. The design does nothing for a couple in Texas or California, where community property already produces the full adjustment through a simpler route. It also does nothing useful for holdings that are worth less than their basis, because inclusion in an estate can cut basis down just as easily as raise it. The common mistake is treating this as a product to buy rather than a position to defend. No published revenue ruling approves the structure and no Tax Court opinion addresses it head on, so a family that adopts it should go in knowing the IRS may disagree and that nobody can promise the adjustment will survive review. That uncertainty is not a reason to avoid the idea, but it is a reason to document everything and to size the expected benefit honestly.

The Reed Corporation is a certified public accounting and tax firm. We do not practice law, and we do not draft joint trusts, powers of appointment, or any other transfer document, so the instrument itself is written by your own attorney. Any opinion on what an asset is worth belongs to a qualified appraiser rather than to a tax preparer. Our share of JEST joint revocable trust basis planning is the modeling before the fact and the reporting afterward, work that runs through our tax strategy consulting group and the individual tax return the survivor files each year. Weigh the projected basis gain against the drafting cost and the audit exposure before anyone signs anything, and look at the decision again whenever the couple changes states or the mix of assets shifts in a meaningful way.

Section 1014(e) is the reason this design has to be handled with care. The rule says that if appreciated property was acquired by a decedent by gift within one year before death, and that same property then passes from the decedent back to the donor or to the donor’s spouse, the recipient takes the decedent’s adjusted basis immediately before death instead of a date of death value. Put plainly, you cannot hand a dying spouse an appreciated asset, wait for the estate to include it, and take it back with a clean basis. Congress wrote the provision to stop that exact trade. Two features of the rule matter in practice. It reaches appreciated property only, so it does not rescue a taxpayer from a step down, and it runs on a hard twelve month clock measured backward from the date of death rather than on any test of motive.

Here is how it bites in a joint trust. When a healthy spouse funds the trust with her own appreciated property and the document hands the sick spouse a power that causes inclusion in his estate, the IRS can characterize that funding as a gift to him made within a year of his death. If the property then flows back to her outright, or into a trust that pays her income for life, the agency can argue that 1014(e) denies the very adjustment the plan was built to capture. Suppose the wife contributes stock with a 200,000 dollar basis that is worth 1,200,000 dollars, the husband dies five months later, and the shares land in a credit shelter trust from which she draws income. If the rule applies, the basis stays at 200,000 dollars rather than climbing to 1,200,000 dollars. A later sale then produces 1,000,000 dollars of gain and roughly 238,000 dollars of federal tax at a 23.8 percent rate, with the character of that gain governed by the rules in Publication 544 and the reporting done on Form 8949.

Attorneys answer the rule in a few different ways. Some direct the includible property into a credit shelter trust in which the surviving spouse holds no beneficial interest at all, which takes the property outside the passing back language. Others limit the survivor to a support standard and accept some risk, since whether a trust for a survivor counts as passing back to the donor has never been settled by a court. The cleanest answer is time. Property that has sat in the joint trust for more than a year before the first death falls outside the rule entirely. That points to the most damaging mistake we see, which is signing a joint trust weeks after a terminal diagnosis. Waiting out the one year window is a plan. Funding a trust three weeks before a funeral is a filing position that will not hold up well.

Our job on the tax side is evidence. We keep a contribution ledger showing which spouse put in each asset, on what date, and what its basis was at that moment, because 1014(e) is decided on facts rather than on labels and those facts have to be recorded while both spouses are living. We also track carryover basis on anything the rule touches so the number is right when the property is finally sold, and we reconcile that record to the values used on the estate return. That recordkeeping sits with our bookkeeping team and feeds the returns prepared by our individual tax return group. Investment income during the administration period follows the ordinary rules described in Publication 550. Build the file as though someone will review it in five years, because on a technique this new the odds of that are not small.

The best candidate is a married couple living in a common law state, holding assets with a low cost and a high current value, whose combined wealth sits below the federal estate exclusion. For that couple the binding constraint is income tax rather than estate tax, and every dollar of extra basis is a dollar of gain that never gets taxed. Long held real estate, founder stock, and farmland are the classic holdings. A second decent fit is a couple where one spouse is meaningfully older or in poor health, since the technique only pays off when the spouse who dies first is not the one who owned the appreciated property. That said, health based planning runs straight into the one year rule discussed elsewhere on this page, so the timing has to be honest rather than opportunistic. Age cuts the other way too. A couple in their early fifties may be paying today for an event three decades out, under rules that will almost certainly be rewritten before the plan is ever tested.

Several couples should pass. Anyone in Arizona, California, Texas, Washington, or another community property state already gets a full adjustment on community assets under existing law, and a few other states offer elective community property trusts that reach a similar place with less strain. Couples whose main asset is a retirement account gain nothing, because an inherited retirement account is income in respect of a decedent and receives no basis adjustment at all. Distributions from it stay fully taxable to whoever receives them, as described in Publication 590-B, and they arrive each year on Form 1099-R. Couples holding property that has dropped below its cost should also stay away, since inclusion in an estate would lock in a step down and destroy a loss they could otherwise have used. One more group can skip the exercise. A couple that intends to leave everything outright to one another, expects no estate tax at either death, and holds property nobody plans to sell may collect most of the same benefit from the ordinary adjustment at the second death without paying for any drafting at all.

Run the arithmetic before the meeting with counsel. Take a couple in Georgia with a house they built for 400,000 dollars now worth 1,400,000 dollars plus a brokerage account with 900,000 dollars of value over 300,000 dollars of cost. Under ordinary joint titling the survivor picks up roughly 800,000 dollars of new basis at the first death. A design that pulls the whole pool into the first estate would produce about 1,600,000 dollars of new basis, and the extra 800,000 dollars saves in the range of 190,000 dollars of tax at a 23.8 percent federal rate if the assets are sold. Against that, subtract the legal fees, the appraisal cost, and the value of the second step-up the family gives up on whatever lands in a credit shelter trust. On a primary residence remember the separate exclusion described in Publication 523, which may already cover much of the gain and shrink the benefit considerably.

The mistake that ruins the analysis is looking at basis alone. A joint trust that succeeds at pulling everything into the first estate also uses up exclusion, changes creditor exposure under state law, and can strand the survivor with less control than she expected. Those consequences are legal questions for your attorney, not accounting questions for us. What we contribute to JEST joint revocable trust basis planning is a clear side by side projection of the tax outcomes under each route, prepared with your actual cost records rather than estimates. That analysis comes out of our tax strategy consulting practice and rests on the asset histories our bookkeeping staff maintain. Re-run the comparison every few years, because a portfolio that made the technique worthwhile at one point can drift toward a profile where it no longer earns its cost.

The paperwork begins the week of the funeral. A joint revocable trust is normally ignored for income tax purposes while both spouses live, since each of them is treated as owner of their share. At the first death part of the trust usually becomes irrevocable, and that part needs an employer identification number of its own, requested on Form SS-4 through the employer identification number application. From that date forward the irrevocable share files its own fiduciary income tax return on Form 1041 each year, reporting income earned after death and claiming a deduction for amounts carried out to beneficiaries. A federal estate tax return on Form 706 may also be filed, sometimes because tax is owed and sometimes only to elect portability or to allocate generation-skipping exemption. That return is due nine months after death, with a six month extension available on request. Where an estate return is filed and property passes to a beneficiary, the consistent basis rules require the executor to report the estate tax value to the recipient on Form 8971 with its attached schedule, generally within thirty days, and the beneficiary cannot then claim a higher basis than the estate reported.

Records matter more here than in almost any other kind of planning, because the whole point of the exercise is a number that will not be tested for twenty years. Keep a date of death appraisal for every asset that is not publicly traded. Keep the contribution history showing which spouse funded what and when. Keep the pre-death basis for each item so a carryover figure is available if the one year rule applies. Then rebuild the depreciation schedules, since property that gets a new basis starts a new recovery period on the stepped up amount. Suppose a building with 1,200,000 dollars of new basis allocable to improvements enters a fresh 27.5 year life. That is roughly 43,600 dollars of additional annual depreciation, claimed on Form 4562 under the rules in Publication 946, and it flows to the rental schedule for as long as the property is held.

Rental activity keeps landing on Schedule E for property the survivor holds directly, with the residential rules explained in Publication 527. Property held inside the irrevocable share reports on the fiduciary return instead, and the two sets of books must not be mixed. That separation is exactly where families slip. Rent gets deposited into the survivor’s personal checking account, repairs get paid from whichever card is handy, and by the second year nobody can say which entity earned what. A trust with commingled accounts is a weak position to defend, and it undercuts the argument that the trust was respected as a separate owner at all. Our bookkeeping team opens the separate ledgers in the first month rather than reconstructing them from statements two years later.

Every JEST joint revocable trust basis planning file should be assembled as a package that a stranger could follow. That means the signed instrument, the funding schedule, the date of death values with the appraisals behind them, the estate return if one was filed, and the depreciation schedules that flow from the new basis. We prepare or review the fiduciary returns and the survivor’s personal return, which our individual tax return group handles each spring, and we keep the basis records tied back to the estate values so the two never drift apart. The firm does not draft the trust and does not issue valuation opinions, and no set of records can promise a particular result on examination. Set the file up correctly in year one, because the cost of building it later, when memories have faded and the appraiser has retired, is far higher than doing the work now.

We work the tax side and we stay in that lane. The Reed Corporation is a certified public accounting and tax firm. We do not practice law, we do not draft trust instruments or transfer documents, and we do not sign valuation opinions on real estate or closely held businesses. Your attorney owns the drafting and the legal judgment about whether a design fits your state. A qualified appraiser owns the values. What we bring is the projection that tells the couple whether the plan is worth doing, the basis and contribution records that support it afterward, and the returns that report the result. We also read the executed document before the first return is prepared, because how the instrument defines income and what powers it gives the trustee change how the fiduciary return is completed.

Cost against benefit is the first conversation, and it should be a blunt one. Say a couple faces 12,000 dollars of legal and appraisal cost to put a joint exempt step-up trust in place, and the projection shows a likely basis gain of 1,500,000 dollars on property they intend to sell within a few years of the first death. At a 23.8 percent federal rate that gain is worth roughly 357,000 dollars, so the spend is easy to justify. Change the facts and the answer flips. A couple with 600,000 dollars of appreciation, no intention of selling anything, and a state that adds its own complications may spend the same 12,000 dollars for a benefit their heirs never collect. We also stress test the projection against a sale that never happens, since a tax saving that depends on a transaction nobody makes is not a saving. We build both versions of that math with real numbers from the client’s own records rather than a rule of thumb, and we say plainly when the answer is that the plan is not worth the trouble.

The mistake we correct most often is a client assuming the accountant and the attorney are talking to each other. Usually they are not. A trust gets signed in one office, assets get retitled by a bank, and the tax preparer learns about all of it eleven months later from a stack of statements carrying a new tax identification number. By then the funding record that section 1014(e) turns on is a matter of guesswork, and nobody can reconstruct which spouse contributed which account or on what date. We ask to be in the room while the design is still being chosen, and we send the attorney a written summary of the tax assumptions the plan depends on so that everyone is working from one set of facts. If the IRS later asks questions, that summary and the underlying records are what answer them, along with a power of attorney on Form 2848 so we can speak to the agency directly on your behalf.

Couples weighing this technique can Request Private Consultation and we will model the basis outcome under both the ordinary rules and the joint trust design before anyone commits to a drafting fee. In an examination we pull the account history through online transcripts and respond within the deadlines described in the IRS explanation of notices and letters. Nothing here is a guarantee of an estate tax, gift tax, or examination outcome, and this technique in particular carries real uncertainty that a family should accept with open eyes rather than on faith. Begin with our tax strategy consulting group or the individual tax return service the survivor will rely on afterward. Basis planning of this kind deserves a fresh look after any move across state lines, since the community property question that drives the whole analysis can change with a single relocation.