When you file for Chapter 7 bankruptcy, you're declaring that you're unable to pay your debts. Bankruptcy offers you protection from your creditors and gives you a fresh financial start. An inheritance adds an important wrinkle to the process; any bequest you receive represents a new asset that the bankruptcy court needs to know about. The bankruptcy rules provide guidelines on when to declare the inheritance and how the court should handle it.
The Bankruptcy Estate
Chapter 7 creates a bankruptcy estate that includes all assets available for the court-appointed trustee to liquidate for payment to your creditors. Your estate might include cash, investments in a brokerage account, vehicles, equity in your home, jewelry, antiques and other possessions. An inheritance that you become entitled to within 180 days of filing for bankruptcy becomes part of your bankruptcy estate. If your uncle dies five months after you file for bankruptcy, anything he leaves you in his will is included in the bankruptcy estate -- it doesn't matter when you actually receive the inheritance. If his date of passing was seven months after the filing, however, the inheritance is off-limits to the trustee.
Notification and Amendments
If your right to an inheritance occurs within 180 days of the date you filed for bankruptcy, you must notify the trustee assigned to your case. You may have to file new bankruptcy schedules or amend the schedules you've already filed to list the assets you've inherited. This is true even if the bankruptcy case has closed and the court has discharged or erased your debts. If the inheritance occurs before the bankruptcy case is filed, then it may be included in the means test that determines whether or not you qualify for Chapter 7. If you fail to disclose the inheritance, or otherwise hide assets, the court can dismiss the case, leaving you unprotected against creditors and unable to discharge any debts. Hiding your inheritance may be construed as bankruptcy fraud and this is a federal crime. Upon conviction, the maximum penalty is a fine of up to $250,000 and up to five years in jail.
Exemptions and Inheritance
Federal and state laws allow a Chapter 7 debtor to exempt a portion of his property from the bankruptcy estate. The exemptions apply to several different categories of property, including real estate, motor vehicles, jewelry and tools. If property is totally exempt, the trustee can't seize it to pay creditors. Whether you can choose the federal or state exemption list depends on where you file for bankruptcy. Some states allow you to choose between the two but others require that you use the state list of exemptions. A "wildcard" exemption allows you to protect additional money or property of your own choosing up to a certain dollar amount, so if it's available to you, you can use it to protect some -- if not all -- of your inheritance, depending on how much you inherit. The federal wildcard exemption as of 2014 is $1,250 plus any unused portion of the exemption for real estate up to $11,500.
The specific language of the inheritance rule describes any property you receive by "bequest, devise, or inheritance." Therefore, a trust or investment account naming you as a beneficiary would come under this definition, as would any account with a transfer-on-death provision. The law also specifically mentions life insurance proceeds or death benefits you may receive.
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- Henry, DeGraaf & McCormick: Exemptions
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Founder/president of the innovative reference publisher The Archive LLC, Tom Streissguth has been a self-employed business owner, independent bookseller and freelance author in the school/library market. Holding a bachelor's degree from Yale, Streissguth has published more than 100 works of history, biography, current affairs and geography for young readers.