Inheritances in Chapter 7 and Chapter 13 Bankruptcy

Posted by William Kain on August 9, 2017 at 7:30 PM
William Kain

Inheritances in Chapter 7 and 13 Bankruptcy.jpegThe clients with whom I meet to discuss filing bankruptcy come in all ages, and genders. Some of my clients are very low-income wage earners; others have fairly high salaries. But my clients have one thing in common: they haven’t had very much good luck financially. For many of these people, filing a bankruptcy case, whether under chapter 7 or chapter 13, is the best option they have to resolve their financial issues. For a small percentage of these people who file bankruptcy cases, the years of bad luck that they experienced prior to filing is changed suddenly when they learn that they will inherit money or property from a deceased loved-one’s estate.

 In some cases, the bankruptcy debtor who inherits money or property does so without the inheritance causing complications. However, for a few of my clients, they are confronted with the irony that this piece of financial good fortune brings with it strings attached.

The Rule Regarding Inheritances In Chapter 7 Bankruptcy

The rule regarding inheritances for Chapter 7 is straightforward: Section 541(1) of the Bankruptcy Code provides that if a bankruptcy debtor becomes entitled to receive an inheritance within 180 days of the day that the bankruptcy case was filed, that inheritance is property of the bankruptcy estate, and subject to administration by the chapter 7 bankruptcy trustee.

The key point here is that the death of a person, from whose estate the debtor will inherit property or money, is the event that triggers the inclusion of the inheritance into the bankruptcy estate. It does not matter if the money or property is not received until after the 180-day period post-filing ends.

Debtors are required to report the possibility of inheriting to their attorney, so that the existence of an inheritance interest is reported properly to the case trustee.

This rule also applies to the debtor’s right to receive a beneficiary payment from a deceased person’s life insurance policy. Again, the bankruptcy debtor who, through the death of another person, discovers the potential to receive a life insurance check has the absolute obligation to report that situation to his attorney so that the life insurance interest can be reported to the case trustee.

For those debtors who have used the Federal Bankruptcy Code to exempt their property, it is possible to exempt some, or perhaps all, of the inheritance interest, provided that the debtor has enough room to do so under section 522(d)(5) of the code. Debtors who do not own real estate, or those who own real estate with minimal equity, have up to $13,100 available to them to use to protect the inheritance interest.

The rule regarding inheritance, then, is fairly straight-forward with chapter 7 cases. Things get more complicated with chapter 13.

The Rule Regarding Inheritances In Chapter 13 Bankruptcy

The first situation I’ll look at with Chapter 13 cases is fairly simple: money or property, to which the chapter 13 debtor becomes entitled to inherit within 180 days of filing is property of the bankruptcy estate and as such, must be accounted for in determining the best interest of creditors test (the test to determine the minimum dividend that will be paid to unsecured creditors). Again, the chapter 13 debtor has a duty to disclose the existence of the inheritance interest to his attorney, who will disclose the inheritance interest to the trustee.

But what about money or property to which the chapter 13 debtor becomes entitled after the 180 period? Chapter 13 has a broader definition of property of the estate than that found in section 541. Section 1306(1) of the Bankruptcy Code defines property of the estate as all of the property defined in section 541 that the debtor acquires after commencement of the case but before the case is closed, dismissed or converted to another chapter. So the 180 day rule that governs chapter 7 cases does not apply in chapter 13.

However, other provisions of chapter 13 raise the question as to whether an inheritance interest that comes into being after a chapter 13 plan is confirmed really is subject to administration in a chapter 13 case. Section 1327 of the Bankruptcy Code provides that unless a confirmed plan states otherwise, confirmation of a plan vests all of the property of the estate in the debtor. And 1327 further provides that property vested in the debtor is free and clear of any claim or interest of any creditor provided for in the plan. So the issue becomes, if the Bankruptcy Code says that no creditor can make any claim against the property of a debtor in a confirmed chapter 13 plan, why would an inheritance have to be administered by the chapter 13 trustee?

The issue is resolved, at least for now, but thinking about the inheritance not necessarily as a property of the estate question, but rather as an issue regarding the chapter 13 debtor’s ability to commit disposable income into the chapter 13 plan payments. Courts have held that the chapter 13 debtor has a duty to disclose the receipt of any “windfall” money during the time the chapter 13 case is active. When seen in this context, the court does not have to determine whether the inheritance is property of the estate. Rather, the question is whether the receipt of the inheritance means that the debtor can afford to pay more money in the chapter 13 plan.

With the exception of relatively small inheritances, the answer to this question is often yes, the debtors can pay more. Debtors in this situation should know that if they have deferred replacing furniture, car repairs, necessary home repairs and the like, chapter 13 trustees will usually be receptive to a proposal that allows debtors to pay for these necessary, sometimes large expenses out of inheritances or property received.

So while inheritance issues do not often come up in bankruptcy cases, it’s important for clients to be aware of the complications that can arise. In all cases involving inheritances, clients should consult with their attorneys so they understand exactly what their rights and responsibilities are.

Topics: Bankruptcy, Chapter 13, Chapter 7