From time to time, we report on bankruptcy court decisions that may be of interest to our clients and friends
Revocable grantor or “living” trusts are a popular alternative or adjunct to a traditional will as a means of passing property to one’s heirs. The grantor legally transfers property into the trust, and is usually both the trustee and, during his lifetime, the sole beneficiary.
In the recent case of In Re: Parr, the Tenth U.S. Circuit Bankruptcy Appellate Panel (a special court which hears certain Bankruptcy Court decisions) considered the question of whether real property to which title is held by such a trust may be retained by a Chapter 7 bankruptcy petitioner as his or her “homestead” or must instead be surrendered to creditors.
It was at one time common practice for both European and American colonial and state courts to sentence those unable to pay their debts to confinement in a “workhouse” or “debtors’ prison”. There they would be compelled to labor without compensation until the debt was considered satisfied. This practice persisted in the United States until around the time of the Civil War.
Nonpayment of private debt is of course no longer punishable by imprisonment. However, as discussed in the “Common Bankruptcy Questions” section of our website, when an individual files a Chapter 7 “liquidation” bankruptcy petition the federal Bankruptcy Code does require him surrender to the trustee most cash and real and personal property. The trustee in turn sells non-cash assets and distributes the proceeds to creditors.
At the same time, the intent of the Code is to give the debtor a “fresh start”, free from most debts. Recognizing that making a debtor destitute by seizing all of his property would be at odds with this purpose, the Code places certain assets beyond the reach of the trustee and creditors. It does this in one of two ways:
– By Exclusion. This means that the asset is not treated as part of the petitioner’s bankruptcy “estate”. A common example is the balance in certain types of retirement and pension accounts.
‒ By Exemption. This means that while the asset is included in the bankruptcy, it is partially or totally exempt from liquidation.
Colorado State Exemptions
The Bankruptcy Code contains a number of exemptions. However, although the Code is a federal law and governs most aspects of bankruptcy proceedings, states may elect to “opt out” of the federal exemption scheme and adopt their own. In our FAQs, we discuss what property a Chapter 7 debtor may keep under Colorado’s exemption system. In addition to household goods, a motor vehicle and some other personal property, a debtor may also exempt the value of the his or her “homestead”.
What Is a “Homestead” in Colorado?
Under Colorado law, a homestead is a house and lot (or lots) or of a farm consisting of any number of acres, occupied by the debtor or the debtor’s family as their residence. As is true in most states, Colorado limits the value which can be exempted (the first $75,000 of value or $105,000 if the debtor is disabled or elderly).
In a Chapter 7 bankruptcy, if the homestead is worth more than the available exemption, the trustee may sell the property and distribute the excess proceeds to creditors.
In Parr We Trust
According to the Bankruptcy Panel’s opinion in Parr, the value of the Englewood property far exceeds the applicable exemption amount. Were Mr. Parr still the owner of record, the trustee therefore clearly could have simply sold the property and distributed the proceeds to creditors, less the allowable homestead exemption.
However, some years before filing his bankruptcy petition Mr. Parr transferred title to the Englewood property to a living trust of which he was sole trustee and, during his lifetime, sole beneficiary. Under the trust documents, Mr. Parr retained the right to remove any trust property at any time.
In finding that the homestead exemption was available as a matter of law, the Bankruptcy Panel looked to state law, noting that the Colorado Supreme Court has previously held that retention of the degree of control which is typical in a grantor trust leaves the grantor with the “functional equivalent” of ownership. The Panel also found, however, that there was a factual question as to whether the Englewood property met the definition of “homestead” at the time of the bankruptcy filing. The Panel therefore remanded the case to the Bankruptcy Court for a determination.
What This Decision Means to You
If you are contemplating bankruptcy and title to your Colorado residence is held by a trust or some other legal entity such as a corporation, the Parr decision suggests that the homestead exemption may be available to you without changing the ownership of the property.
Although simply transferring the property back to yourself or to your family before filing a bankruptcy petition may be an option, it may also trigger serious and unintended bankruptcy and non-bankruptcy (for example, state or federal tax) implications. For this reason, obtaining the advice of experienced legal counsel before making any change in ownership is essential.
If you have questions about the bankruptcy process, we hope you’ll come in for a consultation with an experienced bankruptcy lawyer. You can schedule an appointment by calling 303.331.3403 or by clicking here.