Can You Keep Inheritance Money If You Filed Bankruptcy?
How to Protect Inheritance From Creditors
The bankruptcy code has specific rules about how an inheritance is treated during bankruptcy. If a debtor inherits money before filing bankruptcy or within 180 days after filing bankruptcy, that money will become part of the bankruptcy estate. This bankruptcy rule applies to all types of assets inherited by the debtor, cash, real estate, stocks, bonds, precious metals or anything else of value.
The 180 Day Rule
The 180 day rule was established to prevent debtors from filing bankruptcy right before the death of a relative from whom they would inherit money. Of course, if they could avoid using their inheritance to pay their debts, using bankruptcy to discharge their debts beforehand might seem like the best move for some debtors. To remove this option of using bankruptcy to protect an imminent inheritance, the 180 day rule was established.
Other Ways to Protect Your Inheritance
But despite the 180 day rule there are other ways to protect your inheritance. Bankruptcy exemptions can be applied in your bankruptcy to protect inherited assets. For example, if you inherited a home and made it your homestead, you might be able to use the homestead exemption to protect the home. This also applies to other asset types, such as jewelry or a vehicle.
The only thing the debtor needs to be concerned about, are assets which exceed the bankruptcy exemption dollar amount. For example, if your inherited asset is worth $5,000 and the bankruptcy exemption is only $2,500, the bankruptcy trustee might demand that the inherited asset be liquidated. If the inherited asset is liquidated the unprotected portion will be distributed to the creditors, while the exempt portion will remain with the debtor. In Chapter 13 bankruptcy, if not protected, any inherited money will be used to repay creditors.
Chapter 7 Exemptions
The federal government allows debtors to protect personal property up to a certain amount. Texas law also establishes such exemptions. In Texas, an individual filing for bankruptcy can either choose to use the State of Texas exemptions or the federal exemptions, but you can’t mix and match exemptions to suit your needs; you must choose either state or federal exemptions.
In Texas, a single bankruptcy filer is allowed to protect personal property in the amount of $50,000 per person or $100,000 per family. If you inherited more than $50,000 from your relative, the bankruptcy trustee may be able to claim that money as part of the bankruptcy estate and liquidate it to repay your creditors.
However, in Texas, there are other exemptions that you can claim along with your $50,000 in personal property. In comparison to federal law, there is almost no reason why you would not want to choose the Texas bankruptcy exemptions over the federal exemptions. In fact, Texas restricts access to its exemptions by requiring that residents must have lived in the state for at least 40 months (3.3 years). That is how great Texas exemptions are. In many cases, it would be beneficial for residents from other states to move here to declare bankruptcy so Texas has to put a stop to that. Homestead property is exempted wholly and does not count toward the $50,000.
Using Trusts to Protect Your Assets
If it’s possible that a close relative might pass within six months of your bankruptcy and you stand to be an inheritor, you can request that they place your inheritance in a revocable living trust. If the trust is in your name, however, then you have a problem and it will become part of the bankruptcy estate. In certain cases, you may be able to claim that an item is a family heirloom, but it would still be counted against your exemptions.
If the money is left to (for instance) your parent and their name is on the trust, then any assets in the trust cannot be considered part of your bankruptcy estate. On the other hand, you won’t be able to access this money until 180 days after the bankruptcy is completed. Is it legal to do this?
That depends on how it’s done. Firstly, it will be obvious to the bankruptcy court, your creditors, and the trustee that you are trying to seal these assets off from the bankruptcy estate. If the estate was transferred to you and then sent to a revocable living trust, it will become part of the bankruptcy estate. If you seal off the assets in an irrevocable living trust, you have more protection but less flexibility with your funds. The trustee of the irrevocable living trust can pay you funds out of the trust, but the creditors and the bankruptcy trustee may claim that it’s a fraudulent transfer.
Once you transfer the assets out of your name, the court will hold that you should have gotten something reasonable in return and whatever you got back is considered part of the bankruptcy estate. In other words, they will accuse you of fraud and go after your trust.
What About Asset-Protection Trusts?
Wealthy people in high-litigation fields use asset protection trusts to protect their assets from creditors or from judgments against them in a lawsuit. Essentially, they move their assets into an out-of-state trust in order to protect them. While it’s more difficult to access these funds because they’re out of state, it’s not impossible. And while creditors or lawyers may balk at the effort, when you’re filing for bankruptcy, you’re dealing with federal authorities. Federal authorities will have no problem accessing money in out-of-state trusts and will accuse you of fraud if you don’t list these assets in your bankruptcy estate.
One possible way to protect your inheritance is if the assets were dispersed with a “spendthrift provision”. A spendthrift provision gives certain powers to the trustee when dispersing assets to a beneficiary (even one in bankruptcy). If there is a spendthrift provision in a will or trust, the bankruptcy trustee may not be able to force the beneficiary of the trust to turn over their assets to the bankruptcy estate. Ultimately, the trustee has final say over what happens to the money contained in the trust and if there is a spendthrift provision, the assets may be protected from liquidation, payment to creditors, or becoming part of your total income for repayment in Chapter 13.
Since this is a very complex issue, you should speak with a bankruptcy attorney about the possibility of inheriting a large sum of money during the 180 days after your bankruptcy.