Can a bypass trust avoid capital gains tax when selling appreciated assets? The question of whether a bypass trust—also known as a credit shelter trust or an A-B trust—can avoid capital gains tax when selling appreciated assets is complex, and the answer is often, “it depends.” Bypass trusts are estate planning tools designed to utilize the federal estate tax exemption, shielding assets from estate taxes. However, they don’t automatically eliminate capital gains tax when assets *within* the trust are sold. The crucial factor isn’t the trust itself, but *how* and *when* the assets were transferred into the trust and the specific circumstances of the sale. Roughly 40% of estates are large enough to potentially be subject to estate taxes, making proper trust structuring vital. Understanding the interplay between estate tax and capital gains tax is where things become nuanced.
What happens to the 'cost basis' when transferring assets to a bypass trust? The ‘cost basis’ is the original price of an asset, used to calculate capital gains or losses. When assets are transferred into a bypass trust, the cost basis generally *carries over*. This means if you transfer stock you purchased for $10,000 into a bypass trust, and then sell it for $20,000 within the trust, the trust will recognize a $10,000 capital gain. There's no automatic “step-up” in basis simply by being in the trust. However, upon the death of the grantor (the person creating the trust), the assets *within* the trust often receive a “step-up” in basis to the fair market value at the date of death. This can significantly reduce or eliminate capital gains tax when the assets are subsequently sold by the trustee. The grantor retaining any interest or control over the assets within the trust will negate this