If you receive an inheritance during your bankruptcy case, a question may arise as to whether you need to include the inheritance in your bankruptcy estate.
The answer to this question depends in large part on the timing of your inheritance: the general rule (unless an exception applies) is that if you are expecting an inheritance at the time of filing or become entitled to one within 180 days after filing your bankruptcy petition, the inheritance will become part of the bankruptcy estate.
When this happens, you must inform the bankruptcy court and the bankruptcy trustee of the inheritance. This general rule also applies to any tangible items that you may stand to inherit, like a car, jewelry, or furniture. All of these items are subject to the administration of the bankruptcy estate.
If you receive an inheritance that must be added to your bankruptcy estate, you must also consider the type of bankruptcy protection you are using: Chapter 7 or Chapter 13. Other factors to weigh include whether your spouse’s inheritance needs to be included in the bankruptcy estate and any possible legal ways to protect it from such inclusion.
If you have questions about bankruptcy and your inheritance, please call Stone Rose Law at (480) 739-2448 for a free consultation.
Why is an Inheritance Included in Your Bankruptcy Estate?
Some people try to “game the system” when they resort to bankruptcy protection. In the past, a person who knew he or she would be receiving a large inheritance might file for bankruptcy before receiving it, to protect the inherited assets.
Congress sought to reduce this possibility by creating the 180-day rule, so that you must disclose in your bankruptcy schedules any inheritance you receive within its 180-day period.
The 180-day period is triggered when the decedent dies, and you become entitled to inherit, even if probate or distribution occurs later. It applies to both Chapter 7 and Chapter 13 bankruptcy, and makes inherited property subject to the same exemption rules and protections as all other property.
Inheritances and Chapter 7 Bankruptcy
The effect of the 180-day rule in Chapter 7 bankruptcy is that any inheritance you are entitled to that is subject to the rule will be used to pay off debt unless it is protected by applicable Arizona bankruptcy exemptions (Arizona has opted out of the federal exemption scheme).
Inheritances Received Within 180 Days After Filing for Chapter 7 Bankruptcy
An inherited asset will become part of your Chapter 7 bankruptcy estate, although you will be able to keep your inheritance if you can exempt it. Otherwise, the trustee will take any non-exempt portion of the inheritance to pay your creditors.
Inheritance Received More Than 180 Days After Filing for Chapter 7 Bankruptcy
If you inherit assets or become entitled to inherit assets more than 180 days after you file for Chapter 7, the trustee cannot claim the inheritance, and it will remain your property.
Inheritances and Chapter 13 Bankruptcy
In a Chapter 13 bankruptcy, you do not have to give up your property for liquidation. Instead, you make monthly payments to be divided among your creditors as part of your Chapter 13 repayment plan, subject to whether the property is exempt (like a cash gift), in which case it is not subject to the repayment plan.
A non-exempt inheritance may increase how much you have to repay to your creditors. The Chapter 13 Trustee will demand increased funding to the plan or a supplemental payment to the plan. A supplemental payment is a payment in addition to the base plan amount. A Chapter 13 Bankruptcy Attorney can help you navigate which option is a better fit. Depending on where you are in the process, a modified plan may be required. In some cases, your Chapter 13 Attorney can even negotiate a payoff of your bankruptcy to end the bankruptcy sooner if the inheritance is significant.
Why must you increase the amount paid into your Chapter 13 bankruptcy plan?
Your unsecured creditors (those whose debts are not backed by collateral) are entitled to be paid at least as much in Chapter 13 as they would have received if you had used Chapter 7: this is the value of your non-exempt property. So, if you receive an inheritance that is not exempt, you will have to add its value to what you repay to your unsecured creditors.
Can the Trustee Take Your Inheritance After Bankruptcy Discharge?
Even after you receive a discharge in bankruptcy, if you were entitled to receive an inheritance within the 180-day period, then the trustee may still claim it.
This is because the 180-day inheritance period and the discharge are not directly related. The trustee can claim inherited property for the bankruptcy estate if you become entitled to it any time during the 180-day period after you filed your case.
For example, a Chapter 7 case can be discharged in less than 180 days. Thus, it is at least theoretically possible that the deceased relative from whom you received an inheritance could die after receiving your discharge (the date on which you become entitled to the inheritance) but before the 180-day period is complete.
What If Your Non-Filing Spouse Inherits During Bankruptcy?
If an inheritance belongs to your spouse who did not file for bankruptcy with you, then it is separate property under Arizona law unless it is commingled or transformed into community property through use or agreement.
An example of commingling is when your spouse spends part of the inheritance on buying you an item of property that is non-exempt from your bankruptcy estate.
The Effect of the Size of the Inheritance
If your inheritance is large enough, you might be able to receive at least part of its value after the trustee is finished administering your bankruptcy estate, all creditor claims are paid, and administrative costs are covered.
Possible Strategies to Keep Your Inherited Assets in Bankruptcy
Typically, absent exemptions like the bankruptcy wildcard exemption, little can shield an inheritance within the 180-day rule from inclusion in your bankruptcy estate.
Is it Advisable to Hide an Inheritance?
It is not a good idea to try and conceal an inheritance from the bankruptcy trustee. The risk is high that if you do, the attempt will fail, and you can get into serious trouble for it.
To begin with, an inheritance is a matter of public record, so it would not be hard for the trustee to locate it through a public record search. But that is not the only way that the existence of an inheritance can become known. It is not uncommon for a jealous relative to inform the trustee, and your own attorney can be bound by ethical rules to disclose it to the trustee if he or she learns of it.
Getting caught concealing an inheritance can result in the bankruptcy court requiring you to replace its value into the bankruptcy estate, even if you have already spent it. You could also end up with your bankruptcy case dismissed and face a charge of bankruptcy fraud.
Can a Living Trust Shield an Inheritance from the Bankruptcy Estate?
In Arizona, a revocable living trust with a spendthrift provision generally will not protect an inheritance from being included in the bankruptcy estate unless the grantor dies, the trust is irrevocable, and it contains a valid spendthrift provision. Spendthrift protection depends on trust irrevocability and beneficiary status, and may exclude certain interests under § 541(c)(2).
An experienced Arizona bankruptcy attorney can help you determine whether a living trust can help shield an inheritance from bankruptcy.
Call Stone Rose Law for Answers to Your Questions About Bankruptcy and Inheritance
If you are considering filing bankruptcy in Arizona and believe that you may be the beneficiary of a significant inheritance, the Phoenix bankruptcy attorneys at Stone Rose Law can answer your questions and provide you with legal counsel on how Chapter 7 bankruptcy or Chapter 13 bankruptcy can affect your inheritance expectation under Arizona state or federal law.
Call us at (480) 739-2448 to speak with one of our experienced bankruptcy lawyers, or use our online contact form to set up a free consultation about how bankruptcy proceedings can affect your anticipated inheritance.
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