Swap Powers and Upstream Basis Planning: Getting a Step-Up After Rev. Rul. 2023-2

By Eric Ridley, attorney, Ridley Law. Updated October 2026.

Estate size this page covers: swap powers matter most to families with irrevocable grantor trusts, which usually means estates of $15 million and up for one person, $30 million for a married couple. Upstream basis planning matters most below that line, where a parent’s estate has unused exemption to absorb a step-up. For the larger picture see ultra high net worth estate planning in California.

What is a swap power?

A swap power is a power to reacquire trust property by substituting other property of equivalent value, and when someone holds it in a nonfiduciary capacity without the consent of a fiduciary, the trust is a grantor trust for income tax, under IRC § 675(4)(C).

That grantor trust status is the point of most estate freeze trusts: the creator pays the trust’s income tax, and the trust grows untaxed for the children. When the holder isn’t a trustee, whether the power is held in a nonfiduciary capacity is a question of fact. The regulation says it depends on all the terms of the trust and the circumstances of its creation and administration (Treas. Reg. § 1.675-1(b)(4)).

The swap itself isn’t a sale for income tax. The IRS treats the creator of a grantor trust as owning the trust’s assets, so an exchange between the creator and the trust isn’t recognized as a sale (Rev. Rul. 85-13, as summarized by the IRS in Rev. Rul. 2007-13). No gain is reported when the low-basis asset comes back out.

Does a swap power pull the trust into the estate?

No, as long as the trustee has a fiduciary duty to make sure the property swapped in is of equivalent value and the swap can’t shift benefits among the beneficiaries, according to the IRS in Rev. Rul. 2008-22 (2008).

The ruling looked at estate inclusion under IRC §§ 2036 and 2038. It says a swap can’t shift benefits if the trustee has the power to reinvest and a duty of impartiality, or if the trust’s investments don’t affect the beneficiaries’ interests, as with a unitrust or a trust paying only discretionary distributions. California supplies the impartiality duty by statute: a trustee with two or more beneficiaries must act impartially in investing and managing the trust property (Prob. Code § 16003).

The ruling builds on Estate of Jordahl v. Commissioner (1975) 65 T.C. 92, where the IRS acquiesced in the result. There the creator of a life insurance trust kept the power to substitute policies and securities of equal value. The Tax Court held the power didn’t let him alter the trust and wasn’t an incident of ownership in the policies.

What did Rev. Rul. 2023-2 decide?

It decided that assets in an irrevocable grantor trust, funded by a completed gift and not included in the creator’s estate, don’t get a basis adjustment under IRC § 1014 when the creator dies, according to the IRS in Rev. Rul. 2023-2 (2023).

The reasoning is short. IRC § 1014 gives a new basis only to property “acquired from” a decedent, and § 1014(b) lists the kinds of property that count. Assets that left the estate by completed gift don’t pass by bequest or inheritance, aren’t community property, and aren’t in the gross estate, so they fall outside every category. The trust keeps the creator’s old basis.

Two limits matter. First, the ruling’s facts state that neither the trust nor the creator held a note on which the other owed money, so it doesn’t decide what happens to a trust holding the creator’s note at death. Second, the IRS still lists this basis question as an area under study where it won’t issue private letter rulings (Rev. Proc. 2026-3, section 5), so a family can’t get a ruling on its own variation.

How the swap works before death

1. Inventory basis in the trust

   List every trust asset with its value and basis. The best candidates are low-basis assets the family expects to sell after death, not assets it plans to hold for generations.

2. Line up high-basis property to swap in

   Cash is cleanest. A grantor short on cash can borrow from a bank and swap the loan proceeds in. A promissory note from the grantor is the risky version, for the reasons below.

3. Value both sides

   Marketable securities price themselves. A closely held business, real estate or an LLC interest needs a qualified appraisal dated close to the swap.

4. Exercise the power in writing

   The grantor gives the trustee written notice and certifies that the property going in and the property coming out are of equivalent value, as the facts in Rev. Rul. 2008-22 required.

5. Let the trustee check the values

   The trustee confirms equivalence, keeps the file, and can refuse if the values don’t match. That trustee duty is what Rev. Rul. 2008-22 relies on to keep the trust out of the grantor’s estate.

6. Retitle and record

   Transfer title both ways, update the trust’s books, and keep the appraisal and certification with the trust records for the estate tax return and any audit.

A note is the weak point. A swap paid with the creator’s promissory note leaves the trust holding a note when the creator dies, which is outside the facts of Rev. Rul. 2023-2. Courts and the IRS have also split on how a grantor’s purchase from a grantor trust for a note is treated: the Second Circuit gave the grantor a cost basis in Rothstein, and the IRS’s position in Rev. Rul. 85-13 is that the exchange isn’t recognized at all. Cash, or cash borrowed from a bank, keeps the swap inside the ruling.

Valuation risk and how to document equivalence

Rev. Rul. 2008-22 keeps the trust out of the estate because the trustee has a duty to prevent a swap of unequal value. In the ruling’s words, if the trustee knows or has reason to believe the substituted assets are worth less, the trustee has a fiduciary duty to prevent the exercise of the power. A swap with soft numbers puts that protection at risk and invites a claim from the beneficiaries whose trust came out behind.

The file should hold a qualified appraisal for anything without a market price, the creator’s written certification of equivalent value, the trustee’s own review of both sides, and the closing documents. A family business interest swapped out of the trust is the hard case: the trust gives up an asset that may be worth more than the appraisal says, so the appraiser and the trustee both need to be independent of the family.

Worked example: the swap before death

The hypothetical below isn’t any real family. Lena, a California widow, set up a grantor trust for her children years ago and gave it stock now worth $4 million, with a basis of $400,000. Her own estate holds $4 million in cash. If nothing changes, the trust keeps the stock with its old basis at her death (Rev. Rul. 2023-2). If Lena swaps her $4 million of cash into the trust for the stock, the stock is in her estate when she dies and gets a basis equal to its value then (IRC § 1014(a)).

Assumptions: the stock is worth $4 million on the swap date and at Lena’s death, and the family sells it right after her death. The gain is taxed at the top rates, 20% federal (IRC § 1(h)(1)(D)), 3.8% net investment income tax (IRC § 1411), and 13.3% California, which is the 12.3% top bracket plus the 1% surcharge on income over $1 million (R&TC § 17043). California taxes capital gains as ordinary income (Franchise Tax Board). The model ignores lower brackets and the deduction limits on state tax. Lena’s taxable estate is the same either way, because $4 million of cash went out and $4 million of stock came in.

Upstream basis planning

Upstream planning uses a parent’s unused exemption to buy a step-up. A child, or a trust for the child, gives an older parent a general power of appointment over appreciated property. Property subject to a general power the parent holds at death is in the parent’s gross estate (IRC § 2041(a)(2)), and property included in the gross estate gets a new basis (IRC § 1014(b)(9)). If the parent’s estate stays under the $15 million exemption, the inclusion costs no estate tax.

Numbers make the trade plain. On $3 million of stock with a $300,000 basis, a step-up at a 37.1% combined rate saves $1,001,700 of income tax on a later sale. The cost is that the parent holds real power over the property for as long as the power lasts.

• The power has to be general. It must be exercisable in favor of the parent, the parent’s estate, or the creditors of either (IRC § 2041(b)(1)). A power exercisable only with the consent of the person who created it, or of someone with a substantial adverse interest, isn’t general (§ 2041(b)(1)(C)).
• The one-year rule. If appreciated property was given to the decedent within one year before death and passes back to the donor or the donor’s spouse, the donor’s basis is the decedent’s old basis (IRC § 1014(e)). The rule speaks of property “acquired by the decedent by gift” that passes back to the donor or the donor’s spouse. I found no ruling or case applying it to a general power created in a trust, so plan as if it could apply and wait the year where possible.
• The parent’s creditors. In California, property subject to a general testamentary power, or a general power that was presently exercisable at death, can be reached by the parent’s estate creditors and administration expenses to the extent the parent’s own estate falls short (Prob. Code § 682(b)). A parent with debts or a pending claim is the wrong parent.
• The parent’s exemption. Every dollar included uses the parent’s exemption. A parent whose own estate already exceeds $15 million turns the step-up into a 40% estate tax.

Cases won and lost

• Taxpayer won: Estate of Jordahl v. Commissioner (1975) 65 T.C. 92. A reserved power to substitute policies and securities of equal value didn’t cause inclusion under IRC § 2038 or § 2042. The IRS later relied on the case in Rev. Rul. 2008-22.
• Taxpayer won: Rothstein v. United States (2d Cir. 1984) 735 F.2d 704. A grantor bought stock from his grantor trust for a $320,000 note. The Second Circuit held his basis in the stock was his cost, the $320,000 note. The IRS’s contrary position, that a grantor and grantor trust exchange isn’t recognized at all, is in Rev. Rul. 85-13, which it summarized in Rev. Rul. 2007-13.
• The government’s side is in its rulings, not a court win. Rev. Rul. 2023-2 is the IRS’s answer on basis at death, and no court has ruled on it that I found. Rev. Proc. 2026-3 still lists the question as under study.

What changes in California

Community property and the double step-up

When one spouse dies, the surviving spouse’s half of community property also gets a new basis if at least half of the community property was in the decedent’s gross estate (IRC § 1014(b)(6)). Assets swapped back from a grantor trust funded with one spouse’s separate property come back as that spouse’s separate property in most plans. Turning them into community property to reach the double step-up takes a written transmutation with an express declaration that meets Fam. Code § 852 (Estate of MacDonald (1990) 51 Cal.3d 262), and it gives up separate-property protection in a divorce. See the community property step-up and transmutation agreements.

Prop 13 and Prop 19 when real estate is swapped

A swap involving California real estate is a property tax event, separate from the income tax result. A change in ownership is a transfer of a present interest in real property (R&TC § 60). The trust exclusion covers transfers into a trust only while the transferor is a present beneficiary or the trust is revocable, and transfers back from such a trust to the trustor (R&TC § 62(d)). An irrevocable trust for children is neither, so moving real estate in or out can trigger reassessment. The parent-child exclusion since February 16, 2021 is limited to a principal residence or a family farm, and only when a claim is filed (R&TC § 63.2). Where the trust holds real estate through an LLC, a transfer of the LLC interests isn’t treated as a transfer of the real estate except as R&TC § 64(c) and (d) provide. See Prop 19 planning.

No capital gains rate

California taxes capital gains as ordinary income, so a Californian’s gain is taxed at up to 13.3% on top of the federal rates. That makes the step-up worth more here than in a state without an income tax.

What works and what fails

Who this is for

Families with a grantor trust that holds low-basis stock, real estate or a business interest, where the creator is older or ill, and families with a parent whose estate has unused exemption. The swap power has to be in the trust already. A trust without one may need a decanting or a court modification first.

Working with Ridley Law

The call is for California families with a grantor trust holding low-basis assets, or a parent with unused exemption, weighing what a swap or an upstream power would save on their own numbers. The first call is free and runs 30 minutes, by phone or Zoom. I work alongside your CPA and, where the matter calls for it, co-counsel. Work at this level is built for each family and quoted in writing before any drafting starts.

Book my 30-minute call or call 805-244-5291.

Frequently asked questions

What is a swap power in a grantor trust?

A power, usually held by the person who created the trust, to take back trust assets by putting in other property of equivalent value. Held in a nonfiduciary capacity, it makes the trust a grantor trust under IRC § 675(4)(C).

Does a swap power cause estate tax inclusion?

Not by itself, under Rev. Rul. 2008-22, if the trustee has a fiduciary duty to confirm the values are equivalent and the swap can’t shift benefits among beneficiaries.

What does Rev. Rul. 2023-2 say?

Assets in an irrevocable grantor trust that aren’t in the creator’s gross estate don’t get a stepped-up basis at the creator’s death. They keep the basis they had before.

Is a swap a taxable sale?

Not under the IRS’s view. The creator is treated as owning the grantor trust’s assets, so an exchange between them isn’t recognized as a sale (Rev. Rul. 85-13, summarized in Rev. Rul. 2007-13).

Can I swap with a promissory note instead of cash?

You can, but it’s the risky version. Rev. Rul. 2023-2 assumed neither side held a note, and how a note outstanding at death is treated isn’t settled. Cash, including cash borrowed from a bank, is cleaner.

What is upstream basis planning?

Giving an older relative, usually a parent, a general power of appointment over appreciated property so it’s included in that person’s estate under IRC § 2041 and gets a new basis under § 1014(b)(9), using the parent’s exemption instead of paying capital gains tax later.

Does the one-year rule in § 1014(e) apply to upstream planning?

It applies when appreciated property was given to the decedent within a year of death and passes back to the donor or the donor’s spouse. Whether it reaches a general power created in a trust hasn’t been decided in any ruling or case I found, so the safe course is to plan around it.