While the primary goal of filing bankruptcy is to provide relief from debts, an equally important objective is the protection of all of a debtor’s assets. The Bankruptcy Code does allow for exemptions, which enable an honest debtor to protect assets from seizure and sale by a bankruptcy trustee. These exemptions vary from state to state, so property that may be exempt in one state may not be exempt in another. Additionally, some assets may be entirely exempt, irrespective of value, while other exemptions may be limited by monetary amount. Discussion of assets and how they may be exempted is a fundamental component of any bankruptcy consultation. The failure to identify and exempt assets is almost invariably a flaw in any bankruptcy petition that was filed without the assistance of a competent bankruptcy attorney. This article will address how property that can otherwise be protected may be lost in a bankruptcy case. Even more problematic, a debtor could risk the loss of the discharge of their debts if they fail to properly identify an asset, or the transfer of an asset.
For the sake of this article, we will use a prospective Chapter 7 debtor in Georgia who is filing bankruptcy to eliminate $20,000 in unsecured debt. Among items of personal property and other assets, this debtor has $10,000 in an IRA account. Under Georgia law, these funds are exempt, and the account cannot be liquidated by a Chapter 7 trustee for the benefit of creditors. However, there are ways in which the debtor can forfeit this exemption and lose the IRA funds if she is not careful.
- The easiest way to lose an asset is to fail to disclose it in the bankruptcy schedules. Our firm uses an intake form for potential clients which requests information about various assets, in order to construct a thorough and accurate bankruptcy petition. But if a debtor does not disclose an asset – such as an IRA in this case – then they can lose it in bankruptcy even though there are exemptions available to protect it. Bankruptcy trustees routinely inspect tax returns, bank statements, and other documents regarding a debtor’s financial condition. It is in the process of reviewing such documents that trustees are able to uncover undisclosed financial assets. The IRA could then be liquidated, and the $10,000 would be distributed to unsecured creditors.
- Another way to lose an asset is to change its status prior to the filing of a bankruptcy case. Let’s assume that our chapter 7 debtor meets with a bankruptcy attorney in January, and advises that attorney that she has an IRA. At that time, the bankruptcy attorney lets her know that the funds in the IRA are protected. Several months pass before the debtor actually files her Chapter 7 case in April, and in the interim she cashes out her IRA. The IRA has now lost its exempt status, because it is now simply “money in the bank”. The nature of an asset is evaluated at the time of filing, and not at the time of the consultation, so in this case our debtor would lose the funds liquidated from the IRA unless there were other exemptions available to protect it.
- A debtor can also forfeit the exemption of a protected asset by transferring it to a third party. Exemptions can only be applied by a debtor to property owned by the debtor. Once the property is transferred, the Chapter 7 debtor loses the ability to exempt it. So if debtor in this case were to transfer the funds to another individual, the IRA exemption would be lost.[i] Since our debtor no longer had the funds, the Chapter 7 trustee would have the right to sue the person who received the transferred funds so they could be recovered for the benefit of creditors. If the funds cannot be recovered, then the trustee may seek to have the debtor’s discharge revoked. This means that the debtor will not receive relief from the bankruptcy court, and cannot avoid the collection of debts which existed at the time the chapter 7 case was filed.
The easiest way to avoid these pitfalls is to use a bankruptcy attorney when you file a bankruptcy case. However, using attorney will not automatically protect all of your assets. Full and candid disclosure of your assets – whether personal property or real property – is essential to a successful bankruptcy filing. Communicate with your bankruptcy attorney, and always err on the side of caution. Do not assume anything with respect to your assets! Whether you are in the process of filing a bankruptcy case, or are already in a pending case, do not do anything to change your financial condition or transfer your assets without consulting with your bankruptcy attorney to make sure that you won’t risk your protected property.
[i] An IRA cannot be transferred to another individual without losing its tax-exempt status, so this is for illustration only.