Holding Back Trust Distributions During Bankruptcy
In general, a bequest, devise or inheritance received within 180 days after a bankruptcy is filed is considered property of the bankruptcy estate and can be liquidated by the chapter 7 trustee. 11 U.S.C. §541(a)(5).
A Florida bankruptcy court analyzed whether a debtor in bankruptcy was entitled to a homestead exemption under Florida law in a house that she received post-bankruptcy from the trust of her mother who also died post-bankruptcy. In re Cole, 2016 Bankr. LEXIS 3418 (Bankr.M.D.Fl., 2016). The debtor was living in the house for the 3 years prior to the bankruptcy and intended to continue to use the house as her residence. There was no dispute that debtor was entitled to exempt the house under Florida law.
In Cole, the court held that the debtor’s receipt of the house entitled her to a homestead exemption at the exact same moment that the bankruptcy trustee obtained his rights to liquidate the property. The court ruled that the “tie” should be settled in favor of the debtor. This case could have easily been decided in favor of the bankruptcy trustee.
The real problem: If the house was titled to the mother’s revocable trust, why did the trust transfer the house to the debtor within the 180 days post-bankruptcy? Drafting a trust to allow the holdback of distributions under certain circumstances – e.g. due to bankruptcy – would have eliminated the trustee’s position entirely.
You never know if a beneficiary will require a bankruptcy, so Cole is a reminder of the need for comprehensive trust provisions to allow flexibility to withhold trust distributions under appropriate circumstances.