A CPA who advises ultra-high-net-worth families left a sharp question on one of my posts last week.

I had written about the step-up in basis — how a traditional dynasty trust forfeits it by design. His question was practical. Couldn’t an asset swap down the road get the low-basis assets back out of the trust and into the grantor’s hands before death?

It’s the right question. It’s the question most estate planners have been answering since 2023. And the answer depends on something most people skip — whether the assets ever left the estate in the first place.

The Problem the Swap Was Built to Solve

In March 2023, the IRS issued Rev. Rul. 2023-2. It addressed an intentionally defective grantor trust — an irrevocable trust funded by a completed gift, with the assets deliberately outside the grantor’s gross estate.

The holding was simple. No step-up under IRC §1014.

The grantor paid the trust’s income tax for life. It didn’t matter. Grantor trust status is an income tax concept. Estate inclusion is a separate question. And §1014 only reaches property acquired from a decedent — which, for these trusts, the assets were not.

That left a lot of families holding completed-gift trusts full of low-basis stock, founder equity, and real estate bought decades ago. All of it locked into carryover basis. All of it facing capital gains on the full appreciation when the heirs sell.

The fix practitioners landed on is the substitution power.

How the Swap Works

Under IRC §675(4)(C), a grantor can hold a power — exercisable in a nonfiduciary capacity — to reacquire trust assets by substituting other property of equivalent value.

Here is what that looks like in practice.

Say a grantor funded a completed-gift trust years ago with stock that had a $300,000 basis. That stock is now worth $5 million. The grantor holds $5 million in cash outside the trust.

The grantor exercises the power. The trust gets $5 million in cash. The grantor gets the stock back.

Under Rev. Rul. 85-13, a transaction between a grantor and their own grantor trust isn’t a sale for income tax purposes. No gain is recognized on the swap.

The grantor holds the stock until death. Now it’s in the gross estate. §1014 applies. Basis resets to fair market value. On these illustrative numbers, roughly $4.7 million of gain disappears — about $1.1 million at a combined 23.8 percent federal rate, before any state tax.

And the estate didn’t get bigger. Cash went out. Stock of equal value came in. The swap changes what the estate holds, not how much.

Rev. Rul. 2008-22 is the comfort on the estate tax side. A substitution power held in a nonfiduciary capacity won’t by itself pull the trust into the grantor’s estate under §§2036 or 2038 — as long as the trustee has a fiduciary duty to confirm the substituted property is truly equivalent in value, and the power can’t be used to shift benefits among beneficiaries.

It works. Estate attorneys have been using it since 2023.

Where the Swap Fails

It works on paper. In practice, it fails in four places.

The power has to be in the instrument. If the trust was drafted without a §675(4)(C) power, there’s nothing to exercise. Decanting or modification may be possible depending on the state and the document — but now you’re solving a drafting problem, not a tax problem.

The grantor needs something to swap in. Equivalent value means equivalent value. A grantor who wants $5 million of stock back needs $5 million of cash or high-basis assets on hand. Some practitioners use the grantor’s own promissory note. That approach raises its own questions, and I would not treat it as settled.

Someone has to value it. Publicly traded stock is easy. A closely held business interest or a commercial building is not. The trustee has to confirm equivalence, which usually means an appraisal — and a trustee who signs off on a lopsided swap has a fiduciary problem.

And someone has to act in time. This is the one that breaks most often. The swap only helps if it happens before death. Incapacity, a sudden death, or a family that simply didn’t know the power existed — any of them, and the step-up is gone. Whether an agent under a power of attorney can exercise the power depends on the instrument and the POA. Many families find out the answer at exactly the wrong moment.

The swap is a remedy. Remedies depend on someone remembering to use them.

The Question Underneath the Question

Go back to the CPA’s question. Could a swap get the low-basis assets out of the trust and into the grantor’s hands?

Yes — if the trust removed them in the first place.

The swap exists because a completed gift took the assets out of the estate. It is a way to reverse that removal, one asset at a time, before the clock runs out.

The Dynasty Bridge Trust® is funded without a completed gift. The assets stay in the gross estate, which is the condition §1014 requires, so nothing needs to come back out. I work through that argument in full in Dynasty Trust Step-Up in Basis, including the GST allocation timing and the side-by-side math.

So the swap stops being the plan. It becomes a backup.

Where the Swap Still Belongs

None of this makes the substitution power obsolete.

If you already hold a completed-gift trust — a traditional dynasty trust, a SLAT, an IDGT — the swap may be the most valuable power in the document. Find out whether you have it. Find out who can exercise it if you can’t. And find out what you’d swap in.

For families meaningfully above the federal exemption, the analysis is rarely one structure. A completed-gift trust may make sense for the portion above the exemption, while low-basis assets stay in the estate where the step-up survives. In that layered design, a substitution power on the completed-gift side is worth having — and worth drafting in from day one rather than retrofitting.

The difference is sequence. A swap power fixes a step-up you gave away. A structure that never gave it away doesn’t need the fix.

The Question to Ask

If your advisor tells you a swap power will protect the step-up, ask three things.

Is the power in my trust document? Who can exercise it if I’m incapacitated? And what am I going to swap in?

If the answers are yes, someone specific, and a real plan — the swap can work.

If any of them is “we’ll figure it out later,” the better question may be why the assets left your estate in the first place.

FAQs

What is a swap power in a trust? It is a power under IRC §675(4)(C), exercisable in a nonfiduciary capacity, to reacquire trust assets by substituting other property of equivalent value. It does two jobs at once: it keeps the trust a grantor trust for income tax purposes, and it gives the grantor a way to bring low-basis assets back into the estate before death.

Does Rev. Rul. 2023-2 eliminate the step-up for grantor trusts? No, and the distinction matters. The ruling addressed an intentionally defective grantor trust funded by a completed gift, with the assets outside the grantor’s gross estate. Grantor trust status is an income tax question; estate inclusion is the §1014 test, and they are not the same question. I explain the difference and what it means for trust design in Dynasty Trust Step-Up in Basis.

Does exercising a swap power trigger capital gains? No. Under Rev. Rul. 85-13, a transaction between a grantor and their own grantor trust is not a sale for income tax purposes, so no gain is recognized when the assets change hands.

Can an agent under a power of attorney exercise a swap power? It depends on both documents — whether the trust instrument permits exercise by an agent, and whether the power of attorney grants that specific authority. Many instruments are silent, and silence is usually resolved against the family. This is worth answering while the grantor still has capacity, not after.

Does a swap power pull the trust into my estate? Rev. Rul. 2008-22 provides that a substitution power held in a nonfiduciary capacity will not by itself cause inclusion under §§2036 or 2038, provided the trustee has a fiduciary duty to confirm that the substituted property is equivalent in value and the power cannot be used to shift benefits among beneficiaries. Drafting to those conditions is what makes the comfort available.

Resources

Dynasty Trust Step-Up in Basis · SLATs vs. the Dynasty Bridge Trust® · What Is the GST Exemption · Does an Offshore Trust Preserve the Step-Up in Basis · The Dynasty Bridge Trust®

Structure before stress.

📞 For a confidential legal consultation, contact Bradley Legal Corp. at (888) 773-9399, or complete the intake questionnaire at btblegal.com.

By: Brian T. Bradley, Esq. – National Asset Protection Attorney