Episode 99: Why Your Parents' Trust Could Cost You Thousands

Written By Jillian Mastroianni

Episode 99

Host: Jill Mastroianni

Why Your Parents' Trust Could Cost You Thousands

Your parents may have created an irrevocable trust years ago to protect their assets and reduce estate taxes. But could that same trust leave you with a substantial income-tax bill when you inherit their property?

In this episode, estate planning attorney Jill Mastroianni uses her father's lake house in the Adirondacks to explain how revocable and irrevocable trusts can produce very different tax consequences. Through a simple example involving a $3 million house, she explains how an estate plan designed to save estate taxes could result in $2.5 million of taxable gain when the property is sold.

You'll also learn why estate planning decisions that made sense twenty years ago may deserve another look today, how certain irrevocable trusts can be modified or planned around, and three important questions to ask your estate planning attorney.

What You'll Learn in This Episode

Why the type of trust matters. A revocable trust allows its creator, the grantor, to retain control of the assets. The assets in a revocable trust are included in the grantor’s taxable estate. Certain irrevocable trusts are designed to remove the future appreciation of an asset from the grantor’s taxable estate.

The difference between estate taxes and capital gains taxes. Estate taxes apply when someone dies with an estate exceeding applicable exemption thresholds. Capital gains taxes apply when inherited property is sold for more than its tax basis.

How a step-up in tax basis works. Property included in someone’s taxable estate generally includes a stepped up income-tax basis equal to its fair market value at death, reducing capital gains taxes when heirs sell it.

How a $3 million house could generate $2.5 million in taxable gain. Jill compares two scenarios involving a house with a $500,000 original tax basis. In one, the house receives a stepped-up tax basis at death. In the other, an irrevocable trust preserves the original tax basis, creating a substantial income-tax liability.

Why an irrevocable trust may have been the right decision years ago. Estate-tax exemptions have changed dramatically. In 2026, the federal estate and gift-tax exemption is $15 million per person, although some states have their own estate taxes with lower exemptions.

Why not all irrevocable trusts are the same. Trusts may be created to reduce estate taxes, address long-term care concerns, or protect assets for children and grandchildren. The appropriate planning depends on the family's goals and the trust's provisions.

What a power of substitution can accomplish. Some irrevocable trusts allow the grantor to exchange, or swap, personally owned assets for trust assets of equivalent value. When properly structured, this provides an opportunity to bring appreciated property back into the grantor’s taxable estate to obtain a step up in tax basis at death.

Why reviewing an older estate plan matters. Changes in tax laws, asset values, and family circumstances may mean that a trust created decades ago deserves another look.

Three Questions to Ask About an Existing Irrevocable Trust

If you or your parents created an irrevocable trust years ago, consider discussing these questions with your estate planning attorney:

  1. Why was the trust originally created? Was the goal to reduce estate taxes, plan for long-term care, or protect assets for future generations?

  2. Does the trust still accomplish what your family needs today? Have changes in tax laws, family circumstances, or asset values affected the original planning goals?

  3. What are the income-tax consequences? Does the trust hold highly appreciated real estate or other assets?

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  • Last week, we talked about why giving your children your house while you're alive can have very different tax consequences from leaving it to them when you die. But what if you don't give your house directly to your children? What if you put it in a trust for their benefit? And what if that trust was specifically designed to save your family money on estate taxes? Well, depending on how the trust was structured, you may have solved one tax problem while creating another. Today, I'm going to use my dad's house in the Adirondacks to show you how an irrevocable trust could leave your children with a substantial income-tax bill, and how you can fix it.

    Welcome to The Death Readiness Podcast. This is not your dad's estate planning podcast. I'm Jill Mastroianni — estate planning attorney, death readiness guide, and your translator for wills, trusts, probate, and the conversations most families avoid.

    If you've been wondering things like, "Can a trust protect what I leave to my children?" "What happens if I give someone power of attorney over me?" and "How can I help my parents while respecting their independence?" You're in the right place.

    We have a new foster dog. His name is Kobi and he's about five years old. Kobi had a person. But she could no longer care for him, and she made the difficult decision to surrender him to Detroit Dog Rescue. And for Kobi, it meant that the life he knew suddenly disappeared.

    But Kobi's doing great. He's living with three humans who love him and has three other dogs to play with. Now, you might be wondering what Kobi has to do with irrevocable trusts and income tax. And the answer is, not very much.

    Except that after listening to this episode, you might realize that the planning you or your parents did all those years ago could have some income-tax consequences you hadn't anticipated. But here's what I want you to remember. Laws change, circumstances change, and we make decisions based on what we know and what matters to us at the time.

    And sometimes, as with Kobi, things turn out differently than we expected. But that doesn't mean the story is over. So today, we're going to talk about a potential income tax problem. And we're also going to talk about why an estate plan that made sense twenty years ago might deserve another look today.

    Let me start by explaining why this matters. Imagine your parents put their house into an irrevocable trust twenty years ago. Their attorney recommended an irrevocable trust because they were concerned about estate taxes, and they wanted to preserve as much of their wealth as possible for their children.

    Fast-forward twenty years. Your parents have died. The house has increased substantially in value, and you inherit it. Then you decide to sell it. And you discover something you weren't expecting.

    Because of the way that trust was structured, you could owe income taxes on millions of dollars of gain. But if your parents had kept that same house in a revocable trust, as opposed to an irrevocable trust, you might have owed no income tax on the sale. It’s the same house and the same family, but with very different income tax consequences.

    And here's what makes this especially interesting. The irrevocable trust was probably exactly the right estate planning decision twenty years ago. So how does that happen? Well, to understand it, we need to talk about two different kinds of taxes.

    Estate taxes and income taxes. And we need to understand that planning to reduce one of those taxes can sometimes increase the other. I'm fortunate enough to spend my summers with my daughter at my dad's house on a lake in the Adirondack Mountains in New York.

    My dad lives there year-round, but many of the houses around the lake are vacation homes. And when I'm there during the summer, people sometimes stop by to ask me estate planning questions. Occasionally, someone will even pull up alongside me while I'm out running to ask about something I talked about on the podcast. One of the questions I hear from people in my dad's generation, and increasingly from their adult children, is what they should do with the family vacation house.

    Sometimes they're concerned about estate taxes and often they’re also worried about what happens if Mom or Dad needs long-term care. And sometimes they simply want to make sure the house stays in the family. Those are three very different goals.

    And the planning that makes sense for one of them might not make sense for another. That's why I push back when someone comes to me and says, "My kids told me I need to put my house in a trust." I always start by asking, “What are you trying to accomplish?” Because before you transfer ownership of your house, I want you to understand the problem you’re trying to solve.

    Now, my dad actually owns his house through a revocable trust. And a revocable trust is exactly what it sounds like. It's a trust that the person who created it can revoke or change. My dad can change the terms of his trust. He can sell the house. He can decide to leave the house to someone other than his children. He still has 100% control. And because he retains that control, the house remains part of his taxable estate for federal estate-tax purposes.

    Now, here's why that matters. When my dad dies, assuming the house is still in his revocable trust, its tax basis will adjust to its fair market value at his death. That's what is called a step-up in tax basis. And if you listened to last week’s episode, which I’ll link to in the show notes, you might remember that a step-up in tax basis can make an enormous difference in the capital gains taxes someone pays when they eventually sell inherited property.

    But an irrevocable trust generally works very differently. Many irrevocable trusts are specifically designed to remove an asset’s future appreciation from someone's taxable estate. And that's the kind of trust we're talking about today. For one of today’s examples, we're going to assume that my dad put his house in an irrevocable trust that’s specifically designed to keep the house’s future appreciation outside my dad's taxable estate. And I’m going to make up the numbers for this example.

    Let's say my dad's tax basis in the house is $500,000. Tax basis is what you paid for an asset, adjusted for certain things that happen while you own it. For example, if you purchase a house and later make certain improvements, those improvements can increase your tax basis.

    And your tax basis matters because it's used to calculate your gain when you sell the property. We’re assuming that my dad's adjusted tax basis in the house is $500,000. Now let's say that when my dad dies, the house is worth $3 million. Remember those two numbers. A $500,000 tax basis. And a house worth $3 million.

    Now, let's compare two different situations. In the first situation, my dad’s house is in a revocable trust. He, as trustee of his revocable trust, owns the house. When he dies, the house and all of its appreciation is included in his taxable estate. And because of that, the house receives a new, stepped up tax basis equal to its fair market value at his death. In our example, that's $3 million.

    Now let's pretend I'm my dad's only child and I inherit the house. I decide to sell it immediately for $3 million. What's my taxable gain? In our example, it's zero. I sell the house for $3 million, and my tax basis is $3 million. So there's no gain.

    Now, let's look at a different situation. In this situation, my dad transfers the house into an irrevocable trust designed to minimize estate taxes. Instead of keeping the house in his revocable trust, let's pretend my dad transferred it years ago into an irrevocable trust.

    And let's assume the trust was properly designed and administered so that the house’s appreciation from the date he transferred it into the irrevocable trust is not included in his taxable estate when he dies. My dad dies, and the house is worth $3 million. I inherit it and sell it for $3 million.

    But this time, the house doesn't receive that adjustment in tax basis at my dad's death. Why? Because he transferred, or gifted, the house during his lifetime to the trustee of the irrevocable trust. Unlike a revocable trust, my dad does not control and cannot revoke the irrevocable trust. There, the house retains my dad's original $500,000 tax basis.

    Let's do the math on this sale. I sell the house for $3 million. My tax basis is $500,000. And that means I have $2.5 million of gain.

    Now, I want to make an important distinction here. I'm not saying I owe $2.5 million in taxes. I'm saying I have $2.5 million of gain that could be subject to income taxes, and that could mean a very substantial income tax bill.

    Compare that with the revocable trust. It’s the same house and the same $3 million sales price. But in one situation, I have no taxable gain. And in the other, I have $2.5 million of gain. That's a pretty dramatic difference. And it all comes down to how the trust was structured and whether the house receives a tax basis adjustment when my dad dies.

    Now, you might be thinking, “If the irrevocable trust could create such a large income-tax bill, why would anyone put their house into one?”

    And that's a very good question. The answer is that the irrevocable trust may have been designed to solve a different tax problem. Estate taxes. I’m going to link in the show notes to an entire episode that I did on estate taxes if you want to do a deep dive. Estate taxes are different from the income taxes you might pay when you sell appreciated property. They're taxes that apply when someone dies owning an estate that exceeds the federal or state estate and gift tax exemption thresholds.

    And one way people try to reduce estate taxes is by transferring appreciating assets out of their taxable estates during their lifetimes. Let's go back to my dad's house. Imagine that years ago, the house was worth substantially less than it is today. And imagine my dad was concerned that the value of his estate would eventually exceed the applicable estate-tax exemption. One planning option could have been to transfer the house into an irrevocable trust.

    If properly structured, the irrevocable trust would keep the house's future appreciation outside his taxable estate. And if his estate would otherwise have been subject to estate taxes, that could save his family a significant amount of money.

    So the attorney who recommended the trust might have been doing exactly what was needed at the time. Estate-tax exemptions have changed dramatically over the years. In 2026, the federal estate and gift-tax exemption is $15 million per person. That's a much higher exemption than existed during many earlier periods.

    And while some states, including New York, have their own estate taxes with lower exemptions, plenty of families who were concerned about estate taxes twenty years ago may no longer have the same concerns today.

    Before we talk about what you or your parents can do if your parents have an irrevocable trust, I want to take a few seconds to tell you about The Death Readiness Playbook. If you've been listening to this podcast and thinking, "Okay, I really do need to get my affairs organized, but I have no idea where to start," that's exactly why I created the Playbook.

    The printed copy version includes a beautifully illustrated educational book covering many of the topics we discuss on this podcast, along with a separate workbook where you can record important information, wishes, and instructions for your loved ones. There's also a digital version available.

    And because Halloween seems like a particularly appropriate time to get a little more Death Ready, I'm offering $10 off with the code BOO. That's B-O-O. The offer runs through October 31st, while supplies last. You can find the Playbook at deathreadiness.com/playbook. That's deathreadiness.com/playbook.

    Okay. Back to trusts.

    People use irrevocable trusts to accomplish different goals. Maybe the goal is to reduce estate taxes or the trust is part of long-term care planning. Or maybe they want to protect the house for their children or grandchildren. Those are different planning goals, and they need to be considered separately.

    But if your irrevocable trust was created years ago, it might be time for another conversation with your estate planning attorney. Depending on how the trust was drafted, there may be options to change the income tax consequences.

    For example, some irrevocable trusts contain a provision that allows the person who created the trust to exchange assets they own for assets held by the trust. You might hear this called a power of substitution, or a power to swap assets.

    Let me explain what that means. Imagine the irrevocable trust owns my dad's house, and the house is now worth $3 million. Let's say the trust gives my dad the power to exchange assets of equivalent value. If he has $3 million in cash or other appropriate assets, he may be able to exchange those assets for the house. The trust would receive the substitute assets. And my dad would receive the house back.

    If the transaction is properly structured, the house and all of its appreciation could once again be part of my dad's taxable estate when he dies. And that would allow the house to receive a new stepped up tax basis at his death.

    If he doesn't have $3 million in suitable assets, this particular strategy might not be available. There may be other planning options, depending on the trust and the circumstances. And bringing the house back into someone's taxable estate isn't necessarily the right decision, either. You have to consider the entire estate plan with your attorney.

    The important thing is that an irrevocable trust isn't necessarily something you can never plan around. But you need to understand what you have before deciding what to do about it.

    So if you or your parents have an irrevocable trust that was created years ago, here are three questions I'd encourage you to ask your attorney.

    First, why was the trust created?

    Was the goal to reduce estate taxes? Was it part of long-term care planning? Was it intended to protect assets for children or grandchildren? Understanding the original purpose matters.

    Second, does the trust still accomplish what your family needs it to accomplish today?

    Maybe circumstances have changed, the value of the estate has changed, the laws have changed. Or maybe, the trust is still doing exactly what it was intended to do.

    And third, what are the income-tax consequences of the trust?

    If the trust owns a highly appreciated house or other asset, that could be a very important question.

    Knowing what to ask is a pretty good place to start.

    I want to go back to something I said at the beginning of this episode. Sometimes we make decisions that turn out differently than we expected. And sometimes we look back and think we should have done something else. But we don't get to make yesterday's decisions with today's information.

    My dad did not actually transfer his house into the irrevocable trust I've been describing today. But even if he had transferred it into an irrevocable trust years ago, and even if I eventually inherited it with a very low tax basis, that would be okay with me.

    Because here's the thing about that house. My parents spent decades making it a place where our family gathers. It's where my daughter spends her summers, where we sit on the dock and watch the boats go by, and where we've celebrated birthdays and made memories with people who are no longer here. And none of those memories have a tax basis.

    Now, don't misunderstand me. I absolutely want families to understand the tax consequences of their estate planning decisions. If there's an opportunity to save your children hundreds of thousands of dollars in income taxes, I want you to know about it.

    But I also don't want people to lose sight of what they're actually trying to accomplish. Because the purpose of estate planning isn't to win some kind of tax-minimization competition. It's to take care of the people you love. Sometimes that means sophisticated tax planning or making sure the house passes to the right people. And sometimes it means spending another summer at the lake, making memories.

    And, if you've been meaning to get your affairs organized, here's a little Halloween incentive. Now through October 31st, you can get $10 off The Death Readiness Playbook with code BOO. That's B-O-O. The Playbook combines an illustrated educational guide with a practical workbook to help you organize the information, decisions, and wishes your loved ones will need someday.

    It's available in both digital and hard copy. Visit deathreadiness.com/playbook and use code BOO at checkout. Getting Death Ready might just be the least scary thing you do this Halloween.

    Thanks so much for listening today.

    This is Death Readiness, real, messy and yours to own. I'm Jill Mastroianni and I'm here to help you sort through it, especially when you don't know where to start.

    Hi, I'm April, Jill's daughter. Thanks for listening to The Death Readiness Podcast.

    While my mom is an attorney, she's not your attorney.

    The Death Readiness Podcast is for educational and entertainment purposes only. It does not provide legal advice.

    For legal guidance tailored to your unique situation, consult with a licensed attorney in your state.

    To learn more about the services my mom offers, visit DeathReadiness.com.

     

Jillian Mastroianni
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Episode 98: Why You Shouldn’t Give Your Kids the House Yet