The law is full of questions that have both yes and no answers, particularly when it comes to bankruptcy and trusts. Some trusts can protect your assets from creditors, while others cannot. You may lose property in one type of bankruptcy, but not in another. Successfully using a trust to shield assets before you file depends on a lot of factors.
Chapter 13 vs. Chapter 7
If you file for Chapter 13 bankruptcy, creditors can't get to your property. It doesn't matter whether you retain ownership or place the assets in a trust – they're not in jeopardy because your debts are satisfied through your disposable income each month. You give this money to the bankruptcy trustee, who then distributes it among your creditors. Chapter 7 is a different matter. This is the form of bankruptcy in which the trustee takes control of your property, selling it to raise money to pay off your debts. You're permitted to keep exempt assets, including certain values of equity in your home and automobile, and some personal property. If your assets exceed the amount of exemptions available to you, the trustee liquidates those that are not covered.
Irrevocable vs. Revocable Trusts
Taking bankruptcy out of the equation – you haven't filed yet and maybe you're not sure you're going to if you can otherwise protect your property – assets that you place in a revocable trust are still vulnerable to your creditors. This is because you would typically act as trustee of your revocable trust, and you would also be a beneficiary. These trusts allow you to retain control of your assets, buying and selling them or taking them back into your ownership at will. Therefore, the trust isn't necessarily an impediment to creditors who want to seize the assets in satisfaction of your debts – it's just as though you had retained ownership yourself.
If you form an irrevocable trust, however, you step aside and allow someone else to run it for you. This permanently severs the ownership link between you and the assets you fund the trust with, so they're not typically available to your creditors. Your timing can be important, however. In some states, if you transfer property into the trust at a time when you're already insolvent and owe money, the court will reverse or undo the trust to put the assets back in your ownership, giving your creditors access to them.
Read More: Revocable Trusts & Divorce
The Bankruptcy Abuse Prevention and Consumer Protection Act allows the trustee to "avoid" transfers of property you make to a revocable trust in the 10 years before you file. This means he can undo them, taking the property back into your bankruptcy estate if he believes you moved them into the trust in an effort to avoid paying your creditors. Your bankruptcy estate is the property available for liquidation to satisfy your debts in Chapter 7.
Disclosure to the Trustee
You're legally obligated to divulge the existence of your trust when you file for bankruptcy protection. If your trust is revocable, you can use your bankruptcy exemptions to protect the property within it, just as you could if you still owned the property outright.
Beverly Bird is a practicing paralegal who has been writing professionally on legal subjects for over 30 years. She specializes in family law and estate law and has mediated family custody issues.