Heir Property: 3 Bankruptcy Pitfalls
Not so much a legal term as it is common vernacular, "heir property" is land, homes, or other real property where the record owner is deceased, but no formal process (such as probate) has been used. Ownership vests in the heirs by operation of law, some of whom might have possession and use of the property, but the state of record title is left unresolved. Sometimes, years or even decades go by with "heir property" becoming co-owned by an increasing number of heirs of the original owner.
Heir property issues come up in bankruptcy cases on occasion. In this post, I will highlight three particular issues closely associated with heir property.
Probably the biggest problem with heir property in bankruptcy is the debtor-heir omitting the property from the bankruptcy schedules. This typically comes as a result of one of two mistakes: (1) simply forgetting about the property--as an example, a 1/24 interest in 10 acres of land in upstate New York that once belonged to a great-uncle can be easy to overlook; or (2) not appreciating that an heir's interest in heir property is an asset, and one that needs to be disclosed.
Omitting assets in a bankruptcy case can lead to a variety of complications, including loss of the property, denial of the bankruptcy discharge, or even prosecution for the federal crime of bankruptcy fraud. Presented with the full facts, one's bankruptcy attorney can devise the best strategy going into a case to deal with an unusual asset.
2. Value and Liquidation
Heir property often also brings with it the host of bankruptcy considerations for a valuable asset. While occasionally a debtor might reside on heir property, more often heir property is not the debtor's residence, but either used by another family member or just idle land. Exemptions provide allowances to protect property, but the homestead exemption in North Carolina for a primary residence is much larger than any exemption for non-residential property. When the debtor has a share of non-residential heir property worth more than the $5,000 wildcard exemption, the asset is not completely protected in bankruptcy.
In chapter 7, a trustee may proceed to sell heir property when the debtor's share is worth more than the debtor's exemption. If the debtor's share is small or the value is low, a trustee might decide it's not worthwhile to pursue the paper equity belonging to the debtor or to clean up the title to the property. On the other hand, the presence of co-owners of the heir property will not necessarily stop the trustee from selling the entire property--the bankruptcy code sets out a multi-part test (Section 363(h)) under which the trustee can sell the property and pay the co-owners from the proceeds. A debtor with heir property going into chapter 7 needs to understand the particular risks in his or her case, as there is a potential for significant family acrimony in these situations.
In chapter 13, the risks associated with heir property are lower. Nevertheless, if it has value as a non-exempt asset, the chapter 13 payment might increase due to the liquidation-test. A dispute over value could also emerge and complicate the chapter 13 case.
3. Insider Transfers
Heirs will sometimes attempt to settle-up heir property by conveying various interests amongst each other. There are legitimate reasons for wanting to move heir property into the names of living persons, as this simplifies a number of property transactions. However, when bankruptcy enters the picture, there is a need to carefully evaluate any transfer of property from the debtor, including transfer of an interest in heir property.
Not all transfers of property cause issues in bankruptcy. Rather, the focus is on two particular types of transfers. The first is the so-called " fraudulent transfer," that can be thought of as a gift that removes property from the reach of creditors. The second is the preferential transfer, where the result of the transfer is that one creditor get more than the bankruptcy would have paid him or her. Both types of transfers have rules applying additional scrutiny on transfers to "insiders," which includes many family members of the debtor.
The nature of heir property transactions tends to be between heirs, who are often insiders of each other. It's also common for heirs to have poor documentation of transactions, or to make informal sale or use arrangements that do not stand up well to the bankruptcy process.
If you have heir property or had heir property, that's a fact that needs to be disclosed to your bankruptcy attorney. Expect that if you file bankruptcy, you'd need to gather as much information on the property and the nature of your interest as possible. Like so many things in bankruptcy, heir property is not a show-stopper, but another item to disclose and plan around.