Episode 44: Avoiding the Hidden Tax Trap in Lifetime Gifts
Episode 44
Host: Jill Mastroianni
Avoiding the Hidden Tax Trap in Lifetime Gifts
Jill unpacks one of the most misunderstood estate-planning tools: the irrevocable trust. Using a real-world scenario, she explains how transferring assets too soon can backfire, especially when it comes to capital-gains taxes. If you’ve ever wondered whether your trust is helping or hurting your long-term plan, this episode will help you make sense of what you really need (and what you don’t).
What You’ll Learn in This Episode:
Revocable vs. Irrevocable Trusts. How control, flexibility, and tax treatment differ between the two.
When to Use an Irrevocable Trust. Situations where it can protect family assets or reduce future estate taxes.
The Probate Myth. Why using an irrevocable trust just to “avoid probate” may cause more trouble than it prevents.
Creditor & Divorce Protection. How spendthrift provisions can shield beneficiaries from creditors (and ex-spouses)
Medicaid’s 5-Year Look-Back. What really happens if you transfer assets into a trust too close to applying for long-term-care assistance.
Tax Traps in Lifetime Gifts. Why giving property during life can trigger large capital-gains taxes that could have been avoided through inheritance.
The Unified Estate & Gift Tax Exemption. Understanding how today’s historically high federal estate and gift tax exemption, about $14 million per person in 2025, works, and why most families won’t owe estate or gift tax.
Stepped-Up Basis Explained. How inheriting assets at death can eliminate capital-gains taxes, and why “gifting early” can cost more than it saves.
Practical Takeaway. Estate plans should fit you, your goals, family, and financial reality, not what your neighbor or financial advisor says everyone “should” do.
Resources & Links:
Episode 5: Why You Shouldn’t Worry About the Estate Tax
Episode 19: Why You Need (or Don’t Need) a Trust
Episode 20: What You Need to Know About Medicaid and Protecting Your Mom’s House
Episode 27: Interview with Probate Judge Andra Hedrick
Episode 38: Why You Need (or Don’t Need) a Will
Estate Plan Audit: deathreadiness.com/audit — Understand what you have, identify what’s missing, and make sure it works together
Connect with Jill:
Website: DeathReadiness.com
Email: jill@deathreadiness.com
Learn more about Jill’s services
Subscribe to the Death Readiness Dispatch!
Submit a question for Tuesday Triage
Did you enjoy this episode? Share it with someone you care about.
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Jill Mastroianni (00:00): Irrevocable trusts sound powerful—and they can be—but they’re also one of the most misunderstood tools in estate planning. In this episode, we’ll unpack what they do, what they don’t do, and why too many people have one when they don’t actually need it.
Welcome to the Death Readiness Podcast. This is not your dad’s estate planning podcast. I’m Jill Mastroianni, former estate attorney, current realist, and your guide to wills, trusts, probate and the conversations no one wants to have. If your Google search history includes, “Do I need a trust?” “What exactly is probate?” and “Am I supposed to do something with mom’s Will?” you’re in the right place.
(00:50) Before we dive in, I want to start by sharing a recent review from one of our listeners on Apple Podcasts. She wrote:
“As someone managing two divorced aging parents who have done no more than a simple Will, it is a real mountain to climb! I wish I had known about this podcast earlier! Mom’s planning is mostly done, and now I’m working with my Dad. I’m also doing my own planning so that my two children don’t have to worry about this stuff when my decline begins or if I pass away unexpectedly. Thank you Jill!”
I love this review, not only because it means the podcast is reaching people who need it, but because it captures exactly what this work is about. She’s doing the hard, practical, loving thing: getting her parents’ plans in order and taking care of her own. That’s real death readiness.
So, to that listener, thank you. And to everyone else who’s shared, rated, or reviewed the podcast, thank you, too. Your messages remind me that these conversations matter and that you’re out there doing the work alongside me.
(02:02) Speaking of doing the work… we recently took on a project of our own—moving into a new-to-us house built in 1946. We decided to move entirely on our own. No movers, no help, just us. My husband and I are in our forties, our daughter is fourteen, and our three dogs… well, they provided entirely moral support.
And if you’ve ever moved, you know: no matter how much you downsize and declutter, you always have more stuff than you thought. And no matter how simple a piece of furniture looks—if it came from Ikea, it’s not simple.
When I walked into the bedroom we were moving out of, my husband was still wrestling with the Ikea storage bed. I asked, “How important is it to you that we have a bed?” He looked up, exhausted, and said, “Not very.” I agreed. I’m perfectly happy sleeping on a mattress on the floor.
Then came the dresser. Big, heavy, impossible to maneuver down the hallway or up the stairs. I asked, “How badly do you want this dresser upstairs?” Turns out—we didn’t. The dresser went straight to the basement, where it now lives happily ever after in my office.
(03:29) So here we are: mid-forties, mattress on the floor, one end table that’s too tall for its purpose—and honestly? We’re good. We’re comfortable. We’re living on our own terms, and right now, that’s enough.
The reason I bring this up is because it’s easy to get caught up in what everyone else is doing or what we think we’re supposed to have. I see it in estate planning all the time. People assume they need a complex setup of trusts because that’s what someone they know did. But not every plan needs lots of pieces. Sometimes simpler is better.
And that brings me to today’s topic: irrevocable trusts.
I haven’t talked about irrevocable trusts on this podcast before—and there’s a reason for that. They’re complicated.
But lately, in reviewing clients’ estate plans as part of the Estate Plan Audits that I offer, I’ve been seeing a lot of them.
And I’ve been seeing them more often than I’d expect, often in situations where they don’t really belong. Which tells me it’s time to dig in on the podcast.
(04:46) So today, we’re going to unpack what an irrevocable trust actually is, how it’s different from a revocable trust, and when it might make sense—or really not make sense—for you or your parents’ estate plan.
Before we get into irrevocable trusts, let’s do a quick refresher on trusts, generally, and on revocable trusts, specifically.
A trust is a legal arrangement where one person—the trustee—holds and manages assets for the benefit of someone else, called the beneficiary.
(05:25) A revocable trust is a legal agreement that lets you transfer ownership of your assets into a trust while you’re alive—but you still stay in full control. You can change it, add or remove things, or even cancel it entirely. When you die, it becomes permanent, and the assets titled in the name of the trust are distributed according to your instructions.
The big benefits of a revocable trust are flexibility and avoiding probate. The downsides are that it doesn’t protect against creditors, and it doesn’t give you any tax benefits.
If you want a deeper dive into revocable trusts, check out Episode 19—Why You Need (or Don’t Need) a Trust. I’ll link to it in the show notes.
(06:18) Now, irrevocable trusts, the kind that can’t be changed, come with a different set of benefits and drawbacks. And I’ll say this right up front: when I say that irrevocable trusts “can’t be changed,” that’s a bit of an oversimplification. There are limited ways to modify or terminate an irrevocable trust, but that’s beyond the scope of today’s Tuesday Triage.
For our purposes today, we’re talking about the most common kind of irrevocable trust: the kind one person sets up for someone else’s benefit.
If you’re curious about self-settled asset protection trusts, sometimes called domestic asset protection trusts, that a person might set up for their own benefit, I can cover that in a future episode. But today, we’re sticking with the basics.
To put all of this in context, let’s look at an example.
(07:21) Meet Kate Smith, our fictional client for today.
Kate is 70 years old and lives in South Dakota. She’s single, she’s retired, and she spent her career running a successful interior design firm. She has four adult children, seven grandchildren, and a total estate worth about $7 million, including a $2 million vacation home in Spearfish, South Dakota. She’s also completely debt-free.
By most standards, Kate is a wealthy woman, certainly wealthier than I am. But I want you to stick with me, even if her situation feels a little out of reach. We’re using Kate’s story to walk through estate-planning concepts that matter for everyone, regardless of net worth.
When Kate meets with her estate planning attorney, she has three main goals:
Avoid probate,
Protect assets for her family, and
Minimize taxes.
(08:33) So, could an irrevocable trust help Kate achieve those goals? Maybe.
Could it also make her plan far more complicated than it needs to be? Also maybe.
Let’s break down each of Kate’s priorities to see where an irrevocable trust might help—and where it could cause more trouble than it’s worth.
Let’s start with Kate’s first goal: avoiding probate.
Probate is the court-supervised process for settling someone’s estate after they die. It only applies to assets that are titled solely in that person’s name without a joint owner, beneficiary, or payable-on-death designation.
Avoiding probate is one of the most common reasons people create revocable trusts.
(09:28) Now, an irrevocable trust can also avoid probate for any assets transferred into it. But here’s the catch: that doesn’t make it the right tool for that job. Using an irrevocable trust just to avoid probate can create unnecessary complications, especially around taxes and control of your assets.
If you want a deeper dive into how probate really works—and how to tell which assets are “probate” versus “non-probate”—check out Episode 38: Why You Need (or Don’t Need) a Will. I also recommend Episode 27 in which I interview probate court judge Andra Hedrick.
I’ll link to both episodes in the show notes.
Kate’s second goal is to protect her assets for her children and grandchildren.
(10:29) Now, this is where irrevocable trusts start to sound appealing. People love the idea of them because they often come with creditor protection, not just for the person creating the trust, but for the beneficiaries who benefit from it.
Here’s how that works: When you transfer assets to an irrevocable trust, you no longer own, control or benefit from them. And because you don’t own, control or benefit from them, your creditors generally can’t reach them.
For example, if Kate transfers her $2 million vacation home to the trustee of her irrevocable trust for the benefit of her descendants’, she no longer owns, controls or benefits from that property. And since she doesn’t own it, control it, or benefit from it, her creditors can’t access it either.
It’s similar to if she gave the property outright to her kids. Once it’s out of her name, it’s typically out of reach by her creditors.
(11:43) That said, there’s an important caveat: you can’t make transfers to avoid paying your debts. If Kate had existing creditors and tried to give away her home to keep it out of their hands, that transfer could be considered fraudulent and potentially reversed by a court. In our example, Kate is debt-free so this isn’t an issue.
The irrevocable trust also protects the assets from her descendants’ creditors. And one of the most common “creditors” people want to protect against is an ex-spouse, or a soon-to-be ex-spouse.
South Dakota trust law supports this creditor protection benefit. If a South Dakota trust includes what’s called a spendthrift provision, the beneficiary’s interest is protected from their creditors.
Now, because Kate is 70, I also need to mention Medicaid’s 5-year look-back rule. If Kate gives away money, transfers property, or moves assets into an irrevocable trust within five years of applying for Medicaid, South Dakota can treat those assets as if she still owned them. The idea is that Medicaid is designed for people who truly can’t afford long-term care, not for those who’ve just transferred everything out of their name.
(13:12) That means if Kate were to need Medicaid-covered care within the next five years, she likely wouldn’t qualify.
But in her case, that’s not really a concern. In 2025, the Medicaid asset limit in South Dakota is $2,000 per person, meaning she can only own $2,000 worth of assets to qualify for Medicaid. There are assets that are exempt from being counted for Medicaid purposes, but I’m not going to get into that right now.
With $7 million in total assets—even if she gave away her $2 million vacation home—Kate would still have $5 million remaining. It’s highly unlikely she’d meet Medicaid’s financial criteria asset limit of $2,000 anytime soon.
(14:12) If you want to learn more about Medicaid eligibility, check out Episode 20: What You Need to Know About Medicaid and Protecting Your Mom’s House. I’ll include a link in the show notes.
We’ve already talked about Kate’s first two priorities – avoiding probate and protecting assets from creditors.
Now let’s check in about Kate’s final estate planning priority – avoiding taxes.
The main types of taxes that come into play here are estate tax, gift tax and income tax.
If you’d like a deeper dive into the estate tax, check out Episode 5: Why You Shouldn’t Worry About the Estate Tax. I’ll include a link in the show notes.
(15:01) Let’s start with the basics:
An estate tax is a tax on the total value of someone’s estate at death.
The gift tax is a tax on the transfer of money or property from one person to another for less than what it’s worth.
Most people never actually pay gift tax. You just have to report large gifts so the IRS can count them toward your lifetime estate and gift tax exemption.
South Dakota doesn’t have an estate tax or a gift tax. So the real action is at the federal level.
In 2025, the federal government enacted the One Big Beautiful Bill Act. This law permanently extends many provisions of the 2017 Tax Cuts and Jobs Act. One big change is that it locks in a historically high federalestate and gift tax exemption.
(16:03) For 2025, the federal estate and gift tax exemption is about $14 million per person.
Starting in 2026, it increases to $15 million per person. And, this exemption is indexed to increase with inflation.
So what does that mean for Kate? Unless something major changes in Congress, Kate’s $7 million estate is well below the federal estate and gift tax threshold. The value of Kate’s estate would have to more than double before we’d be concerned about her owing any federal estate or gift tax.
So, the bigger concern isn’t the estate or gift tax—it’s income tax. And this is where a lot of people, even with good intentions, get tripped up.
(17:00) Let’s go back to Kate’s $2 million vacation home in Spearfish, South Dakota and add a few more facts to this fictional scenario.
Kate’s mother originally bought that home in 1989 for $100,000, back when it was a fixer-upper and Spearfish wasn’t as popular as it is today. Over the years, she put another $100,000 into renovations.
Then, in 2010, when the home had appreciated significantly, Kate’s mom decided to give it to Kate.
A year later, in 2011, Kate’s mom passed away. At that time, the property was worth about $1 million.
Now, for this example, we’ll assume Kate’s mom didn’t owe any gift tax on that transfer of the vacation home to Kate. She did file a federal gift tax return, but no tax was actually due.
We’ll circle back to the gift tax part later.
(18:02) For now, let’s focus on income tax—because this is where things get interesting.
To understand income tax on the sale of an asset, you need to know one key concept: tax basis.
Your tax basis in an asset is basically what you paid for it, plus the cost of any improvements you made to it. It’s what the IRS uses to figure out how much profit, or “gain,” you make when you sell it.
The lower your tax basis compared to the sales price, the higher your taxable gain—and the more tax you’ll pay.
Now, here’s why that matters for estate planning:
When you give someone an asset during your lifetime, you also give them your tax basis—what you paid for it plus the cost of any improvements. When you inherit something after someone’s death, or when you die and someone inherits from you, that tax basis in the inherited asset is “stepped up” to the asset’s fair market value at the date of death.
That “step-up” can make a huge difference in the amount of tax owed later.
(19:19) So let’s look at what that means for Kate.
When Kate’s mom gave her the vacation home in 2010, Kate also received her mom’s tax basis of $200,000—the $100,000 purchase price plus $100,000 she spent on renovations.
If Kate’s mom had held onto that home until she died in 2011, Kate’s tax basis would have been “stepped up” to its $1 million date of death value.
That’s an $800,000 difference in tax basis, and it’s exactly why timing and method of transfer matter so much in estate planning.
Let’s talk about why that matters using Kate’s specific facts.
Let’s say Kate sells the property today for $2 million. With a $200,000 tax basis, her taxable gain is $1.8 million. For simplicity, let’s assume a 20% tax rate for $360,000 of long-term capital gains tax due.
(20:35) Now if Kate had inherited it instead at her mom’s death, with a $1 million tax basis, her taxable gain would be $1 million. For simplicity, again assuming a 20% tax rate, she would owe only $200,000 in long-term capital gains tax.
And if Kate keeps the property until her death, her children would receive a new step-up in tax basis equal to whatever the property is worth at that time. Meaning, if they sold it immediately after her death, they’d owe no capital gains tax at all.
Now, you might be wondering: “If the estate tax exemption ever goes down, shouldn’t Kate go ahead and transfer that $2 million home into an irrevocable trust now just to get it out of her taxable estate?”
It’s a fair question and one of the biggest misconceptions I see.
(21:41) If Kate gives away her $2 million vacation home during her lifetime, she’s not removing it from her taxable estate. She’s just using up part of her lifetime exemption. The estate tax exemption and the gift tax exemption are unified, meaning they work together.
Because South Dakota doesn’t have a gift tax and the federal exemption is about $14 million per person, Kate wouldn’t owe any immediate tax. But she’d report that $2 million gift on a federal gift tax return, and the IRS would subtract it from her lifetime exemption at her death.
So, yes, she’s moved the asset out of her name, but not out of her taxable estate. What she has removed is future appreciation in the property.
(22:37) Let’s say the vacation home is worth $3 million at Kate’s death. If she transferred the property to the irrevocable trust when it was worth $2 million, that extra $1 million in growth won’t be included in her taxable estate at her death.
Sounds good, right? Maybe not.
Remember that tax basis we talked about earlier?
If Kate transfers the $2 million vacation home to the irrevocable trust today, the trust still has her mom’s $200,000 tax basis in the vacation home. If the trust sells the vacation home for $3 million, it pays capital gains tax on $2.8 million of gain.
(23:27) If Kate had kept the property and transferred it at her death, her beneficiaries would get a tax basis of $3 million, the fair market value of the property at Kate’s death—and if they sold it for $3 million, they’d owe zero dollars in capital gains tax.
So, by giving the property away during her lifetime, Kate might save on a future estate tax she was never going to owe—but create a massive capital gains problem instead.
Even if Kate’s estate doubled from $7 million to $14 million, she’d still be under the $15 million estate and gift exemption in 2026, which is indexed to increase with inflation. So, in this case, the irrevocable trust didn’t save her any taxes at all.
(24:24) So, what’s the takeaway from Kate’s story?
Irrevocable trusts can be powerful tools but they’re not a one-size-fits-all. They can protect assets and in limited situations decrease estate taxes. But they can also add unnecessary complexity if they’re used for the wrong reasons.
Just like that Ikea bed we decided not to reassemble, sometimes the simpler option works better, even if it’s not what everyone else is doing. What matters most is that your plan fits you: your goals, your family, and your financial reality.
If you’re not sure whether your plan makes sense—or if you’ve inherited a plan that feels like it was built for someone else—that’s where my Estate Plan Audit can help. It’s designed to help you understand what you have, identify what’s missing, and make sure it all works together the way it should. Visit deathreadiness.com/audit to learn more. That’s deathreadiness.com/audit. I’ll include a link in the show notes.
(25:31) And remember: estate planning isn’t about keeping up with anyone else’s version of “perfect.” It’s about creating a plan that gives you peace of mind—on your terms.
If you have a question you’d like me to answer on a future Tuesday Triage episode, submit it at deathreadiness.com/tuesdaytriage. That’s deathreadiness.com/tuesdaytriage. The link’s in the show notes.
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.
(26:16) 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.
