Written by attorney Mohammed Omar Badwan

Converting Non-Exempt Assets to Exempt Assets Pre-Bankruptcy

Any competent attorney should aid their clients in exempting as much property as possible before filing bankruptcy. The more property that is exempted, the more property the honest but unfortunate debtor gets to retain. However, one must be very careful of not committing bankruptcy fraud when planning their affairs before filing the bankruptcy. Many clients ask me if they can put their savings into their exempt retirement plan (IRA, 401k, etc) before filing bankruptcy. The question is very difficult to answer. The best answer I can give, is "it depends".

The Seventh Circuit has ruled In Re Smiley that "conversions of assets from non-exempt to exempt forms within the year preceding a petition for bankruptcy are not necessarily fraudulent to creditors." Legislative history of the bankruptcy code indicates that Congress intended for debtors to be able to make full use of their entitled exemptions. However, a debtor may not convert non-exempt assets to exempt assets if the conversion was made with the intent to defraud creditors. That is what makes answering the question so difficult. A debtor filing for bankruptcy obviously would like to retain as much of their personal property as possible to aid them in their "fresh start". The question becomes: how can a debtor convert the non-exempt assets to exempt asset without fear of defending against a trustee adversary claiming that the conversion was an effort to defraud creditors of property they would have been entitled to pre-conversion. The answer is not very clear and it seems that many debtors are not willing to take their chances with a questionable conversion. According to In Re Smiley, in order to recover a transfer as fraudulent, the trustee much establish each of the following elements: 1) that an interest of the debtor in property was transferred; 2) that the transfer of that interest occurred within one year before the date of filing of the bankruptcy petition; 3) that the debtor received less than "reasonably equivalent value" in exchange for the transfer at issue; 4) that the debtor was insolvent on the date of the transfer or became insolvent because of the transfer." As you can see, whether a debtor can convert their savings into a retirement plan before filing bankruptcy is a fact-sensitive issue that must be analyzed on a case-by-case basis. Therefore, I can not stress the importance of consulting with a competent attorney when contemplating bankruptcy.

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