An inheritance is treated differently as to the timing of your bankruptcy filing.
Your Assets in Bankruptcy
Most people who file bankruptcy can keep everything they own that they want to keep. That’s usually because all of their assets are “exempt”—protected from their creditors under bankruptcy.
If all your assets aren’t exempt, they can often be protected through other means. As just one example, Chapter 13 “adjustment of debts” can often shield assets that aren’t exempt. It’s important to know whether you have any assets that aren’t protected so that the right steps can be taken.
Today we look at one special kind of asset that you might not usually think of: an inheritance. An inheritance would usually not be exempt. Plus, there are some special rules about inheritances that are worth knowing, even if you’re not expecting to get one.
“Pre-Petition” and “Post-Petition” Assets?
We put up a blog post on November 9 about the difference between “pre-petition” and “post-petition” assets. Essentially, everything you own as of the moment your bankruptcy case is filed are considered pre-petition assets. Everything you earn or acquire after that moment are post-petition assets.
This is important especially in Chapter 7 “straight bankruptcy” because normally only pre-petition assets are part of your case. Post-petition asset don’t need to fit into any exemption because they are not part of your case. That’s an important part of your “fresh financial start”—after the point in time when you file, you are generally free to earn and acquire income and assets beyond the reach of your creditors.
But inheritances are an important exception to this.
Possession of Assets
Here’s one last point before getting to the special rule about inheritances. It’s a seemingly simple but very important point. Your pre-petition assets include not just what you are in immediate possession of but also what you have a right to even if not in your possession.
Your pre-petition assets include “all legal or equitable interests of the debtor in property as of the commencement of the case.” (Section 541(a)(1) of the U.S. Bankruptcy Code.) Doesn’t matter where that property or asset is located or whose possession it’s in.
Take the example of a classic car that you and your uncle are restoring in his garage. If it’s your car, if you’re on the title, of course it’s your asset. When you file a Chapter 7 bankruptcy it’s a pre-petition asset regardless where it happens to be located. So if you want to keep the car it needs to be covered by an exemption, or be protected in some other way.
But now let’s say your uncle actually owns that car—he bought it and only he’s on the title. What if his will says that you’ll inherit it from him? He’s still the owner and you’re not. Just because his will says you’ll get it when he dies does not give you any right to it now. He could change his will to give the car to somebody else. You simply have no “legal or equitable interest” in the car now, or when you file your Chapter 7 case. It’s not a pre-petition asset.
An Inheritance as Part of Your Chapter 7 Case
That is, that car is not a pre-petition asset, not part of your Chapter 7 case, if your uncle is alive when you file your bankruptcy case. It’s totally different if you file bankruptcy after he has died. Then whatever you are to receive through his will would be considered yours for bankruptcy purposes.
That’s true regardless if the car is still in your deceased uncle’s garage and/or still titled in his name. Doesn’t matter that his will still has to go through the probate process before the title transfers to you and you can take possession of the car.
By the way, this is also true if you don’t know that your will says he left the car to you. In fact it’s true even if you don’t know that your uncle has died as of the time you file your bankruptcy case. Whatever assets you have rights to by law are yours for bankruptcy purposes regardless of your knowledge about them.
Special 180-Day Inheritance Rule
So a potential inheritance is not considered yours if you file bankruptcy when your uncle is alive. But bankruptcy law throws a very important curve here. If within 180 DAYS AFTER you file bankruptcy you “acquire or become entitled to acquire” an inheritance—through the death of the person from whom you are inheriting—then the property being inherited is counted as if it was your property at the time you filed. (Section 541(a)(5) of the Bankruptcy Code.)
In other words, if your uncle in our example dies within 180 days after you file bankruptcy, the car would be part of your bankruptcy case. It would have to be protected through an exemption, a Chapter 13 case, or in some other way. Otherwise the Chapter 7 trustee (on behalf of your creditors) could take it from you to sell and pay the proceeds towards your debts.
Includes “Bequests,” “Devises,” “Life Insurance,” and “Death Benefits”
This 180-day-after bankruptcy-filing rule applies not only to property received by inheritance. It also applies to what you acquire “by bequest” and “devise,” plus “as a beneficiary of a life insurance policy or of a death benefit plan.” (Section 541(a)(5)(A) and (C).)
So, these include property you receive through another’s death, whether or not the person had a will. It includes what you receive by “intestate succession”—by the laws which distribute a decedent’s assets when there’s no will.
Awkward but Crucial Timing
This 180-day rule can give you some awkward timing problems.
What if you have a relative who you know is leaving something to you and who is not in good health? What if the amount being left to you is big enough to pay off your debts? You may be hoping to avoid filing bankruptcy by using the expected inheritance to pay off those creditors. If so you’re probably trying to hold off your creditors in the meantime as you’re holding off on filing bankruptcy.
But of course you have no control over the time of death. And even after that who knows how long after that you would actually receive the money. You also probably don’t know how much you’re getting and whether it’s enough to take care of your creditors.
So simply filing bankruptcy now may make more sense. It would increase the likelihood that it would be filed more than 180 days before the death. If so, it’s considered a post-petition asset, outside the jurisdiction of your bankruptcy case.
Or what if you are expecting to inherit a relatively small amount, not nearly enough to pay off your debts? You would understandably prefer that it all not go to your creditors. If so, you want to file your case more than 180 days before that person dies. In general you want to file sooner rather than later to increase those odds.
This is clearly a delicate area. It’s especially so if it’s likely that the person will die within the next 180 days. There may be ways of protecting that inheritance or life insurance if it’s received before filing bankruptcy. A Chapter 13 case may be more appropriate than a Chapter 7 one.
But please be aware that asset protection methods and procedures are potentially dangerous, filled with traps for the unwary. That’s especially true of efforts made to shield asset before filing bankruptcy. All of this really should be done only with detailed advice from an experienced Louisville bankruptcy lawyer who knows your whole situation.