Transferring assets before you file for bankruptcy raises all kinds of red flags with the bankruptcy court. Unless significant time -- as much as two to 10 years -- passes between the transfer or sale and the date of your bankruptcy petition, you may create a big headache for yourself and earn the disfavor of the bankruptcy trustee. This is the case even if you make a seemingly innocent transfer to a family member or your spouse. Sometimes making the transfer to someone in your inner circle -- called an insider -- is even worse.
Exempt and Nonexempt Property
All your property falls into one of two categories when you file for bankruptcy: It's either exempt or nonexempt. Nonexempt property is available to your creditors to satisfy your debts in Chapter 7. You must pay its value to your unsecured creditors in a Chapter 13 plan. In either case, these assets represent money that rightfully belongs to your creditors, so the court doesn't want to see it move out of your bankruptcy estate.
You can usually sell or transfer exempt property without getting into trouble. These assets were never available to your creditors anyway. They were yours to keep, so what you do with them doesn’t particularly affect your bankruptcy proceedings.
Nolo offers a full list of bankruptcy exemptions to help you figure out what's exempt in your state.
Getting Fair Market Value
Selling property rather than giving it away might not alert the bankruptcy court, as long as you receive fair market value. If you own artwork valued at $1,000 and you sell it for $1,000, this might be OK, depending on what you do with the proceeds. If you spend it on necessities, this might be acceptable to the court. If you sell it for $350 during the time leading up to your bankruptcy filing, the court will notice -- particularly if you “sell” it to a friend or family member. This implies you’re just trying to move it out of your bankruptcy estate so the trustee and your creditors don’t have access to it. The court may view this as a fraudulent conveyance.
Results of an Illegal Transfer
Depending on the nature of the transfer, the court might deal with it in a variety of ways. The trustee is authorized to reclaim property, pulling it back into your bankruptcy estate so it’s available for liquidation to pay down your debts. If you sell your vehicle to your son, he may have to give it back if you file for Chapter 7. He’s entitled to make a claim for reimbursement as part of your bankruptcy proceedings, and if he does, he becomes a creditor. If a portion of the property would have been exempt, this could cause you to lose the exemption.
If you use the proceeds from the sale of assets to improve your home or pay down your mortgage, you might lose your homestead exemption or the court might reduce it so you can’t protect as much equity. If there’s sufficient equity in the property, the court can sell it.
You may be denied a bankruptcy discharge. In severe situations -- such as if you tried to transfer a substantially valuable piece of property with the intention of taking it back later -- you could face criminal penalties.
Timing Is Critical
The trustee will normally ask at your meeting of creditors -- the "341 meeting" -- whether you’ve transferred any property within the last year. Bankruptcy petitions ask the same question. But longer look-back periods often apply.
- Normally, the look-back period for transfers is two years. But if your state’s laws allow for a longer period, local rules would apply in most cases.
- If you used the money to increase the value of your home, you could be facing a look-back period of as long as 10 years.
- If you transfer property valued at $600 or more to a creditor, the look-back period is only 90 days.
- If you transfer money or property to an insider, such as your spouse, a family member or business associate, the 90-day look-back period increases to one year.
- Nolo: Selling Nonexempt Property Before Filing for Bankruptcy
- Bankrate: Three Common Property Mistakes in Bankruptcy
- Cadden & Fuller: Bankruptcy Law – Understanding Fraudulent Conveyances
- AllLaw: Bankruptcy Clawbacks of Preferential and Fraudulent Transfers
- Nolo: What Not to Do Before Bankruptcy
- Nolo: Bankruptcy Exemptions by State
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.