Can Inherited Property Be Included in a Bankruptcy?

Under Arizona law, property a debtor acquires within 180 days of filing bankruptcy is part of the bankruptcy estate. The property may be acquired by “bequest, inheritance, or devise”. What if a debtor receives property through a beneficiary deed? In the case of In re Jones Bankruptcy., 487 B.R. 224 (2012) the Arizona Court Court of Appeals considered this issue.

Facts of the Case

Mr. Jones and Mrs. Jones were a married couple living in Arizona. Husband’s grandmother owned a house in Arizona. In July 2010, she executed a beneficiary deed in favor of Mr. Jones and later recorded it.

The beneficiary deed conveyed the house to Husband when she died. Husband and wife filed for bankruptcy on December 28, 2011. Husband’s grandmother died three days later. The bankruptcy trustee moved to sell the house as part of the bankruptcy estate. Mr. Jones and wife objected, arguing it was not an asset of the bankruptcy estate. The Court took the matter under consideration. This opinion set out its decision.

Was Property Acquired by Beneficial Deed a Devise?

In Arizona, the filing of a bankruptcy petition creates an estate that includes all of a debtor’s interests in property. This includes any property interest the debtor acquires by bequest, devise or inheritance within 180 days after filing. Here, husband acquired the property within 180 days of filing the bankruptcy petition. However, husband argues that he did not acquire the property “by bequest, devise or inheritance”.

All parties agree that the property did not come to Mr. Jones as a “bequest” or “inheritance.” The sole question now becomes whether the house became the property of the estate “by devise”.

The Arizona Probate Code uses “devise” as a noun. It defines “devise” as a testamentary disposition of real or personal property. Therefore, the house is a devise if Mr. Jones acquired it as a “testamentary disposition”.

The Arizona Probate Code does not define “testamentary disposition”. Black’s Law Dictionary says it is “a disposition to take effect upon the death of the person making it”. It adds that the person making the devise “retains substantially entire control of the property until death”. The issue here is whether the beneficiary deed executed by the husband’s grandmother is a “testamentary disposition”.

Arizona first adopted the beneficiary deed in 2001. No decisions interpret Arizona’s beneficiary deed statute or its treatment in bankruptcy. The Court looked to how courts treated other non-probate instruments, like trusts. The Court reviewed the case In re Coumbe, 304 B.R. 378 (9th Cir. BAP 2003) on whether an instrument is testamentary. There, the Ninth Circuit Bankruptcy Appellate Panel distinguished between testamentary trusts and inter vivos trusts.

Inter vivos trusts are effective during the maker’s lifetime. The Coumbe court ruled that distributions from inter vivos trusts are not testamentary. Therefore, they are not part of the bankruptcy estate.

It arrived at the opposite result for distributions from testamentary trusts, since they aren’t effective until after the makers’ death. The court ruled that income distributions from a testamentary trust are testamentary dispositions and bankruptcy estate property.

The key distinction is that testamentary trust dispositions pass to the beneficiary upon the death of the trustor. This was also the case with Mr. Jones’s grandmother’s beneficiary deed. Here, the grandmother executed her will and the beneficiary deed on the same date. This shows that the grandmother’s intention was to effect a transfer of property on her death. That is a testamentary disposition.

Alternative Basis

The Court also found that Mr. Jones’s contingent interest in the grandmother’s house also makes it the property of the estate. Under the Bankruptcy Code, the bankruptcy estate consists of “all legal or equitable interests of the debtor in property as of the commencement of the case”.

The term “property” has been broadly construed to include contingent property interest. Here, the husband was to acquire the property when his grandmother died. On the date of the bankruptcy petition, she was still alive. Therefore, the bankruptcy estate did not include ownership of the house. But it did include the contingent interest Mr. Jones had in it.

Disposition

The Bankruptcy Court ruled that the property is part of the bankruptcy estate. Therefore, it granted the Trustee’s Motion to Sell the Property free and clear of liens.

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