By Kitty J. Lin
In general, all of the assets that you own are supposed to be disclosed as part of your bankruptcy estate when you file for bankruptcy (with certain exceptions of course). Are assets you transferred into a revocable living trust part of your bankruptcy estate as well? The answer is yes, they are part of the bankruptcy estate even though the trust is a separate legal entity.
A revocable living trust is normally used as a probate avoiding tool. All the assets included in the trust do not have to go through probate court. This may save significant time and money for the beneficiaries: they get their inheritance faster and they have more of the inheritance left over for them. Upon the passing of the settlor or grantor (person who transferred the asset into the trust to create the trust) the assets in the trust are distributed based upon the wishes of the settlor or grantor.
Although the revocable living trust is a great probate-avoiding tool it is not a great bankruptcy planning tool. That’s because a revocable living trust is revocable. The trust can be modified or revoked at any time. If the owner of the trust assets decides he or she no longer wants the asset to be in a trust, the owner can take the asset out of the trust. If the owner wants to sell the house he or she has the power to do so because it is still their property. It is this freedom that makes the trust a poor bankruptcy planning tool. The bankruptcy trustee steps into your shoes when you file for bankruptcy. Everything you have access to, the trustee and your creditors do as well. That means that the trustee may have the power to sell your house if it is not properly exempted. If you have assets in a revocable living trust you should consult with bankruptcy attorneys to determine if the assets can be protected or not before filing bankruptcy. It may be counter productive if you file for bankruptcy and end up losing your house or other significant assets you may have.
An example of the above situation is if you transferred your house worth $500,000 into a revocable living trust. You name yourself the trustee for the trust during your lifetime. The house has a $250,000 mortgage in your name that still needs to be paid off. If you file a Chapter 7 bankruptcy case without the advice of a lawyer it may be detrimental to your case. Some people may think that an asset in a revocable living trust does not need to be included in the bankruptcy estate because the trust is a separate legal entity. You may end up potentially losing your home if you do not have adequate legal counsel to guide you. That is because there is no bankruptcy exemption with a limit high enough to protect $250,000 in equity in your home (depending on the jurisdiction in which you live, a couple of states have unlimited homestead exemptions). Once you have filed a Chapter 7 case you cannot voluntarily dismiss it at any time either once you find out that it is detrimental to your finances. You will have to stick it out and abide by the orders of the court. This is why it is essential to consult with bankruptcy lawyers when you have any assets that may need protecting. There may be some types of irrevocable trusts that may be excluded from the bankruptcy estate. They may be excluded because you do not have access or control over the trust and therefore the bankruptcy trustee may not have access or control over these trusts. It is highly recommended that you seek the advice of competent legal counsel to advise you on such matters.