When you owe money, your creditors and the courts generally do not care what assets you use to settle a debt. One source of cash a creditor may try to obtain is an inheritance you have received. Generally, when you receive an inheritance, you get outright ownership of the decedent’s former assets, which can be used to pay off liabilities. Whether the creditor can compel you to pay your debts from your inheritance depends on several factors.
To compel you to pay off a debt, a creditor must sue you. Distribution of inheritance property is a matter of public record, so a creditor might see you have assets and decide to sue you to settle the debt. The creditor would submit a complaint to a local court that explains why you owe him money, quantifies how much you owe and asks the court to compel you to pay that amount. The court then determines a hearing date so it can determine the merits of the complaint and whether you should be compelled to pay. The creditor must notify you of the hearing so you can have the opportunity to reply and contest the claims. The court will then hear the case and determine what you owe.
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How a Creditor Collects
If the court determines you owe money to the creditor, it will issue a judgment that compels you to settle the debt. The order may specify for you to use assets obtained through an inheritance. How the judgment will be settled depends on what type of property the inheritance is. If you received cash, the court may order the bank account levied, which would allow the creditor to seize the contents of a named bank account to settle the debt. If the inheritance is real estate, the creditor may place a lien on the property. A lien will grant the creditor security so that if you sell the land, your creditor can settle the debt from the proceeds. In some circumstances, a lien can compel you to sell the land to settle the debt.
Some inherited real estate is protected from liens via a Homestead Exemption. If you live in the inherited property, it cannot be sold to settle a debt if the amount of your equity in the home is less than an amount decreed by the state where the property is located. Assume a state sets an exemption amount at $50,000. If your equity in the property is $25,000, the property cannot be sold.
Disclaiming the Inheritance
If you have debts, you may want to “disclaim” the inherited property. By disclaiming, you surrender all rights to the inheritance, which is then transferred to your lineal descendents -- generally, your children. To ensure a creditor cannot claim the property, you should disclaim the property before you actually receive it. If you take possession of an inheritance and then give it to your children, a court may reverse the transaction and give the property to the creditor, by claiming the transfer was fraudulent and meant to deprive the creditor of what is owed.
If your inheritance is conveyed to you via a spendthrift trust, it is protected from claims by your creditors. A trust is a separate legal entity that holds property for the benefit of beneficiaries. If it has a spendthrift clause, beneficiaries, such as yourself, cannot take assets out of the trust for any reason; you can only receive the property when the terms of the trust agreement permit distribution. As a result of this prohibition, your creditors cannot claim the assets in the trust. However, when the trust makes a distribution to you, your creditors can take what you receive, if the creditor has a court order.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.