Optimizing for Basis in the High-Exemption Era

The permanent $15 million unified exemption ($30 million for married couples) inverts traditional estate architecture: most affluent families will never owe federal estate tax, making income-tax basis planning their primary objective. Their real adversary is the income tax—the capital-gains bill heirs pay on low-basis assets. For decades, estate planning meant pushing assets out of your estate to dodge a 40% transfer tax. Today, unless your net worth exceeds the statutory exemption, keeping appreciated assets in the taxable estate captures the IRC §1014 basis step-up at death (section “Capital Gains Resets With Inheritance”), erasing embedded capital gains entirely. Gifting appreciated assets during life is now frequently a mistake: it transfers low carryover basis to recipients and forfeits the step-up, exchanging an estate tax you would never have owed for a capital-gains tax your heirs will certainly pay.

Three techniques operationalize this:

The swap (substitution) power

An intentionally defective grantor trust (section “Intentionally Defective Grantor Trusts (IDGTs)”) can be drafted so you retain a power to substitute assets of equivalent value ( IRC §675(4)(C)). Late in life you swap high-basis assets (or cash) into the trust and pull the low-basis, highly appreciated assets back out, into your own estate—so those assets get the step-up at your death while the trust still removes future appreciation on what remains. The swap is not a sale; it triggers no gain (Rev. Rul. 85-13). This is the single most useful retrofit for older irrevocable grantor trusts holding appreciated property.

Upstream basis planning

If you hold low-basis assets and have an elderly parent or relative with unused exemption and little wealth of their own, you can give that person a general power of appointment over the assets. The property is then included in their estate under IRC §2041, gets a step-up at their death, and passes back to you or your heirs—using up exemption that would otherwise die with them. The risks are real (their creditors, their change of heart, the one-year rule of IRC §1014(e) if they leave it back to the donor), so it demands a trusted relationship and careful drafting.

Do not reflexively fund the bypass trust

As covered under bypass trusts (section “Bypass Trusts”), sheltering assets from the survivor’s estate also forfeits the second step-up. When the estate is comfortably under the combined exemption, relying on portability (section “Post-Mortem Planning: The Levers You Pull After Death”) to capture two step-ups usually beats a bypass trust that saves an estate tax you were never going to pay. Run it both ways before the first death locks the choice.

A Worked Example: The Swap A decade ago you seeded an IDGT with $2 million of founder’s stock (cost basis $200,000); it is now worth $10 million. Your total estate is $12 million—comfortably under the $15 million exemption—so you will owe no estate tax. But that stock sitting in the trust gets no step-up at your death, because it is outside your estate. Leave it there and your heirs inherit the $200,000 basis and a $9.8 million latent gain. Instead, exercise the swap power: move $10 million of cash (or high-basis securities) from your personal account into the trust and take the $10 million of low-basis stock back out, into your own name. No gain is recognized on the exchange (Rev. Rul. 85-13). At your death the stock steps up to its $10 million fair-market value, and your heirs sell for roughly zero gain. For a California resident, the avoided tax on the $9.8 million gain—20% federal, plus the 3.8% net investment income tax, plus 13.3% state—is about $3.6 million. The constraint is the catch: you must already own $10 million of equal-value assets to put in, which is why the swap is a late-life basis-and-liquidity maneuver, not a costless transaction. Meanwhile the cash you swapped in keeps growing inside the trust, still outside your estate.

The exception remains the genuinely large or fast-growing estate: once you are over the exemption, the 40% transfer tax dominates the 20%-plus capital-gains tax, and pushing appreciation out through GRATs, SLATs, and dynasty trusts wins again. The art is knowing which side of the line you are on—and that the line is now $15 million, not $1 million.