Can You Avoid Capital Gains Tax With a Trust?

Capital gains represent the profit realized from the sale of an asset that has appreciated in value, such as real estate, stocks, or other investments. These gains are generally subject to taxation. Trusts, as legal arrangements for holding and managing assets, offer powerful tools in financial planning. They involve a grantor, who creates the trust; a trustee, who manages the assets; and beneficiaries, who receive the benefits. This structure provides a flexible framework for asset protection, management, and distribution.

Trust Structures and Capital Gains Principles

A key difference lies between revocable and irrevocable trusts. A revocable trust allows the grantor to retain control over the assets, including the ability to modify or terminate the trust at any time. Because the grantor maintains control, assets held in a revocable trust are still considered part of their taxable estate and do not offer capital gains tax avoidance during the grantor’s lifetime.

Conversely, an irrevocable trust requires the grantor to relinquish control over the transferred assets. Once established, the terms of an irrevocable trust generally cannot be changed or canceled without the consent of the trustee and beneficiaries. This surrender of control means that assets placed in an irrevocable trust are removed from the grantor’s taxable estate, which can have significant estate tax benefits and, in some cases, capital gains tax advantages depending on how the trust is structured.

Further distinctions arise between grantor and non-grantor trusts, which determine who is responsible for paying income tax, including capital gains tax, on trust assets. In a grantor trust, the grantor remains responsible for the income tax liabilities of the trust, even though the assets are legally held by the trust. In contrast, a non-grantor trust is considered a separate taxable entity, and either the trust itself or its beneficiaries are liable for the income tax on trust assets.

A “step-up in basis” at death impacts capital gains on inherited assets. When an asset is inherited, its cost basis is adjusted to its fair market value on the date of the deceased’s death. This adjustment can effectively eliminate capital gains tax on any appreciation that occurred prior to the deceased’s passing. Assets held in certain trusts, such as a revocable living trust that becomes irrevocable upon the grantor’s death, can qualify for this step-up in basis, providing a substantial tax benefit to beneficiaries.

Specific Irrevocable Trust Applications

One such structure is the Charitable Remainder Trust (CRT). A CRT allows highly appreciated assets to be transferred to the trust, which then sells these assets without incurring immediate capital gains tax. The trust subsequently provides an income stream to the grantor or other non-charitable beneficiaries for a specified term or for life. The remaining trust assets are then distributed to a qualified charity at the end of the trust term. This arrangement enables the sale of appreciated assets without upfront capital gains tax while providing an income stream and supporting a charitable cause.

Another powerful tool for capital gains planning is the Intentionally Defective Grantor Trust (IDGT). An IDGT is strategically structured to be treated as a non-grantor trust for estate tax purposes, effectively removing the transferred assets from the grantor’s taxable estate. However, it is designed to be a grantor trust for income tax purposes, meaning the grantor remains responsible for paying the income taxes on the trust’s earnings, including capital gains. This allows the assets within the trust to grow income-tax-free from the beneficiaries’ perspective because the grantor pays the tax. This effectively “freezes” the value of the assets for estate tax purposes while allowing future appreciation and income to accumulate outside the grantor’s estate.

While other irrevocable trusts like a Spousal Lifetime Access Trust (SLAT) or an Irrevocable Life Insurance Trust (ILIT) can hold appreciating assets, their primary purpose is typically estate tax planning rather than direct capital gains avoidance. A SLAT, for instance, allows one spouse to make a gift to a trust for the benefit of the other spouse and potentially other beneficiaries, removing assets from the grantor’s estate. An ILIT is primarily used to hold life insurance policies outside the taxable estate.

Essential Planning Elements for Trust Creation

Careful consideration is needed for trust creation for capital gains planning. Selecting the appropriate assets for transfer is important, with highly appreciated assets or illiquid assets often being prime candidates.

When assets are transferred to an irrevocable trust via gift, a tax principle known as “carryover basis” applies. This means the trust assumes the original cost basis of the grantor for the transferred assets. Consequently, if the trust later sells these assets, the capital gains calculation will be based on the grantor’s original purchase price, not the fair market value at the time of transfer to the trust. This differs from the step-up in basis received for inherited assets.

Transferring assets into an irrevocable trust often constitutes a taxable gift, which can have gift tax implications. For 2025, individuals can gift up to $19,000 per recipient annually. Gifts exceeding this annual exclusion amount begin to utilize the grantor’s lifetime gift tax exemption, which is $13.99 million per individual for 2025. While exceeding the annual exclusion necessitates filing a gift tax return (IRS Form 709), actual gift tax payment occurs only if the total lifetime gifts surpass this exemption.

Beyond the legal drafting, a trust must be formally “funded” by transferring assets into it for it to be effective. This involves retitling assets, such as real estate, brokerage accounts, or business interests, into the name of the trust. Failure to properly fund a trust means the assets remain outside the trust structure, negating any intended tax or estate planning benefits.

The complexity of trust law and its interplay with tax regulations requires consulting with experienced estate planning attorneys and tax advisors. These professionals can provide tailored guidance, ensure compliance with applicable laws, and help structure the trust to align with specific financial goals.