Thursday, July 1, 2010

My house is in a trust. Is it protected in a Bankruptcy?

Question of the week: My house is held in a nominee trust, primarily for estate planning purposes. If I were to file for bankruptcy, would my house be protected if I filed a Chapter 7 Bankruptcy?

Answer: There are a number of factors that all address whether or not a debtor's house is exempt from the bankruptcy estate, or whether the bankruptcy court could require the debtor to sell his property to pay some (or all) of his debts. For example, whether or not the debtor actually resides in the subject property or if it is held as an investment property; the total net equity in the property, including mortgages or other liens; and the debtor's exemption elections could all affect how a debtor can protect (or, conversely, risk) a house and your other various assets upon filing a Chapter 7 petition.

First, in Massachusetts, recall that there are two separate exemptions schemes which define what types of property you are allowed to retain, and cannot be sold by the Chapter 7 Trustee to be distributed to your creditors: Federal Exemptions and Massachusetts Exemptions. Generally speaking, the federal exemptions are better suited to protecting your tangible personal property, such as automobiles, bank accounts, etc., but cannot protect more than approximately $21,625.00 worth of equity in a homestead. In situations where you are seeking to protect more than $21,625 in home equity, the Massachusetts Exemptions can protect up to $500,000.00 in home equity, at the cost of significantly reduced exemptions for personal property (i.e., $700.00 equity in an automobile, for example). The caveat is that in order to benefit from the Massachusetts Exemptions, you must file and record a Massachusetts Declaration of Homestead.

Ownership of real property through a nominee trust creates a legal impediment to protecting your equity in your home, however, in certain circumstances, the court has essentially ignored this impediment.

In situations where a trust is the legal titleholder of the debtor's residence, and not the debtor, there is a legal question of whether the debtor is still permitted, by law, to file a Massachusetts Declaration of Homestead. A 2007 Massachusetts Bankruptcy Court case titled “In re: Edward R. Szwyd” decided that “property held in trust is not eligible for Homestead protection. Only individuals may claim a Homestead.” However, in Szwyd, the debtors nevertheless filed a homestead declaration and the Court allowed the Homestead to stand. In this case, the debtor was the sole trustee and beneficiary and no trust existed under Massachusetts law, because the legal protections of the trust merged into the sole trustee and beneficiary, making the debtor the sole beneficial “owner” for purposes of the bankruptcy code.

UPDATE: The law in this area has developed rapidly and swung widely on the issue since 1995. The most recent decision, and currently viewed to be the controlling law with respect to Massachusetts bankruptcy case, is In re Olga M. Rodrigues, 2010 WL 716192 (Bankr. D. Mass., 2010). The Rodriguez decision looked to the statutory language of the Massachusets Homestead Act, which permits a person who “rightfully possess[es] the premises and occup[ies] said home as a principal residence” to file a Declaration of Homestead on the property.

As long as the debtor resides in the house, the debtor may file a Declaration of Homestead to protect the debtor’s interest in the home, even if that interest is little more than a right to ownership upon revocation of the trust. Debtors should take the Rodriguez decision to mean that even in the case of a self-settled trust, nominee trust or merged trust (or any trust where the trustee has significant discretion regarding the trust assets) that trust may be breached by the trustee, and the assets included in the bankruptcy estate. However, the legal form of ownership of the debtor’s residence (including whether the property is held in trust) will no longer serve as a bar to the election of Homestead Act protection, and provides a means of exemption under the Massachusetts bankruptcy exemptions.

If you own property that is held in a trust, and are considering bankruptcy, it is important that you understand the trust which is the legal titleholder to your property as well as the nuances of the United States Bankruptcy Code. If you have questions regarding how to protect your assets through a Chapter 7 Bankruptcy, contact Kelsey & Trask, P.C. for a one-hour consultation at 508-655-5980.


  1. Scenario: Let's say John holds title to one home and mortgage is Owner-Occupied, in Community property state.
    John & Wife, Jane purchase a second home (owner occupied mortgage), with both names on title. John is unable to sell the first home, therefore he conveys/gifts it to his parents (twice, in 3months), who in turn, transfer it to a Family Trust one month later. Under the Family Trust, John is a Trustee and Beneficiary. Jane is not.
    John decides to file Bankruptcy 23 months after the transfer to his parents.
    Is this Property protected from Bankruptcy?
    Or is it considered an asset that the Trustee could pursue?
    OR would it be viewed as a Fraudulent Transfer (with the apparent Badges of Fraud)?
    AND If the latter applies, who would lay claim to the property, and how would it be divided, if it is an Fraudulent Transfer &/or Asset?

  2. I seem to remember seeing this question on the bar exam.

    First, I am a Massachusetts bankruptcy attorney. So, while bankruptcy law derives from the same federal statutes, there are differences in various jurisdictions. So, I would certainly be sure to pose your question to a bankruptcy attorney in your state (which I assume is not Massachusetts because you mention John and Jane are in a community property state).

    As a general rule, whether a community property state or not, judges take a dim view to the argument that property titled in the name of only one spouse is not the property of the other spouse for purposes of assets of the bankruptcy estate. Certainly there are exceptions, but most often, the general rule applies.

    Depending on the level of equity in the debtors' primary residence - the one not in the trust - 11 U.S.C. 522(d)(1) would exempt $21,625.00 of net equity in the home, ($43,250.00 for a joint filing). In Massachusetts, the Debtor could elect to file under the Massachusetts exemption scheme, and under M.G.L. c. 188 s. 1, could protect up to $500,000.00 worth of home equity.

    With respect to the property in the trust: There is no specific exemption to protect a second home, however, depending on the net equity (or lack thereof) in the primary residence, 11 U.S.C. 522(d)(5) permits the debtors to exempt any unused portion of their 11 U.S.C. 522(d)(1) exemption - including all $21,625.00 of it - if the primary residence had no equity or the debtor's intention was to surrender it to the secured lender or the property had no equity.

    Assuming that the debtor structured his exemptions in such a way that would permit him to exempt the asset, we now turn to this issue of a fraudulent transfer. The debtor's parents would be treated as insiders. Transfers to "insiders", which includes relatives, general partners, and directors or officers of the debtor, made up to one year prior to the filing of a bankruptcy, may be avoided or undone. ln addition, the Trustee may be able to avoid transfers under applicable state law, which may provide longer time periods. (See 11 U.S.C. 547(b)).

    With respect to the issue of fraudulent transfers, The trustee may force the return of the property that was made or incurred on or within one year before the date of the filing of the petition, if the debtor voluntarily or involuntarily made such transfer with actual intent to hinder, delay, or defraud creditors, or, if the debtor received less than a reasonably equivalent value in exchange for such transfer or obligation, and was insolvent on the date that such transfer was made or such obligation was incurred, or became insolvent as a result of such transfer or obligation.

    In your example, there are certainly factors that would suggest a Trustee may attempt to avoid the transfer on the basis of fraudulent transfer issue, but the burden would fall on the trustee to prove intent to defraud, which is a factual issue and will depend largely on the debtor's actual intent.

    In any case, the asset must be disclosed to the trustee on the petition as an asset (beneficial interest in trust or estate plan), as well as the debtor's statement of financial affairs as a transfer effected in the past 2 years.

  3. Here's and interesting twist on this subject...
    Suppose we throw in the IRS to this soup.
    The Transferor uses the property mortgage interest as a deduction on the 1040E-form?
    Now what affect would there be on the Transferor and/or the Transferee?
    What are the challenges posed?

  4. Although what happens on a tax return does not necessarily control in Bankruptcy Court, who claims the mortgage interest deduction could be evidence as to who is actually paying the mortgage and/or owns the home. This could be considered evidence by the trustee of a fraudulent transfer. Of course, this would depend on all of the circumstances.


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