The federal gift and estate tax exemption is $15 million for 2026, so most people won’t be liable for these taxes. However, capital gains tax on assets held in an irrevocable trust can have unwelcome tax consequences. Fortunately, the stepped-up basis rules can significantly reduce capital gains tax for loved ones who are the beneficiaries of your irrevocable trusts.  Because of this significant benefit, it’s important to proactively reposition your assets while you’re still alive and well to help ensure that the greatest amount of appreciation qualifies for a basis adjustment.

What’s basis?

In general, basis is what an owner paid for an asset, adjusted for improvements, depreciation and return of capital. Capital gain (or loss) equals the sale price minus the basis.

The basis for most inherited capital assets (such as stocks, real estate, business interests or collectibles) is adjusted to fair market value on the date of death (or, if elected by the executor, the alternate valuation date of six months later). The heir’s new basis is that value, eliminating the tax on any unrealized gain or loss that accumulated during the deceased person’s life.

For example, let’s say that Jack bought stock years ago for $50,000. At his death, it’s worth $220,000. Jack’s son, Ethan, inherits the stock. Ethan’s adjusted basis is $220,000. If he sells the stock immediately for $220,000, there’s no capital gains tax. If he holds on to it and sells it later for $260,000, he’ll only recognize the $40,000 post-death gain.

Important: Some assets, such as inherited retirement accounts, don’t receive a basis adjustment. In addition, assets that have declined in value may receive a step-down in basis rather than a step-up.

Why does asset ownership matter?

Many estate plans transfer appreciating assets into irrevocable trusts or family entities to reduce estate taxes and protect wealth. While these strategies can accomplish important estate planning objectives, they may also prevent highly appreciated assets from receiving a step-up in basis if those assets are no longer included in the owner’s taxable estate.

As a result, individuals sometimes find themselves personally owning cash or other high-basis assets while the most highly appreciated investments remain outside the estate. In these situations, a strategic asset exchange may improve a family’s overall tax outcome.

How do strategic asset swaps work?

Some irrevocable trusts are intentionally drafted to give the grantor the power to substitute assets of equivalent value. “Swap powers” allow the grantor to exchange trust-owned assets for   personally owned assets of an equivalent value  without triggering income tax consequences, provided the exchange satisfies applicable legal requirements.

For example, a grantor might exchange cash or high-basis securities held personally for low-basis, highly appreciated stock held in the trust. After the exchange, the appreciated stock is once again personally owned and may qualify for a step-up in basis at death, while the trust receives assets with little built-in gain.

Considerations before making a swap

Asset substitution strategies aren’t appropriate for every situation. The exchanged assets generally must have equivalent fair market values, making qualified appraisals important in many cases. Other important factors include liquidity needs, creditor protection, investment objectives and the provisions of the governing trust documents.

In addition, these strategies require balancing income tax savings against potential estate tax consequences. For families whose estates may be subject to federal or state estate tax, bringing additional assets back into the taxable estate could increase estate taxes if not carefully evaluated. It’s also important to note that state estate or inheritance taxes may also apply at thresholds below the federal exemption amount.

Future tax law changes also deserve consideration. Estate tax exemptions, capital gains rates and basis adjustment rules have all been the subject of legislative proposals over the years, making regular estate plan reviews an important part of long-term tax planning.

Review your estate plan

Strategic asset swaps are generally most effective when implemented well before they become necessary. Reviewing trust provisions, identifying highly appreciated assets and evaluating potential substitutions early can provide greater flexibility and allow time to obtain any required appraisals, trustee approvals and documentation. 

Because every family’s circumstances are different, these techniques should be implemented only after consultation with qualified tax and legal advisors.