A South Carolina resident can usually protect over $56,000 of value in a home from creditors. But if he decides to plan what happens to his property at death using a living trust, that protection disappears, according to a recent decision from a South Carolina bankruptcy judge. Judge Helen (Beth) Burris reached this conclusion in a case decided in December 2012.
The living trust as a will substitute
The decision arose out of the popular estate planning device known as a “revocable inter vivos trust” but usually referred to as a “living trust.” Instead of writing a will to direct where the owner’s assets go at death, the owner signs a document creating a trust and then transfers the assets into it. During the owner’s lifetime, he is the both the trustee and beneficiary of the trust, meaning he can pretty much do whatever he could do without the trust arrangement. However, when the owner dies, another designated person becomes the beneficiary — effectively, the owner of the property.
The main reason lawyers use this approach is to avoid probate. Since the property is already in the trust, when the owner dies, the new beneficiary automatically gets it, or at least the full benefit of it. It is not tied up while the owner’s probate estate is being handled, creditors of the estate can’t reach it, and information about the assets doesn’t become a public record. I see these estate planning methods used frequently in my Columbia-area bankruptcy practice.
The problem is, because of Judge Burris’ ruling, the owner’s creditors now can reach a home during the owner’s lifetime, even though it would otherwise be protected by the homestead exemption.
The Franklin case
The decision involved Donald and Sharon Franklin, who set up a joint living trust in 2008 and deeded their home in Greer into the trust. Four years later, Donald filed chapter 7 bankruptcy and claimed a homestead exemption to protect his half of the $100,000 equity in the property. Donald’s bankruptcy trustee objected to the exemption, and Judge Burris found the exemption did not apply.
In bankruptcy court, state law determines what property debtors can exempt. The South Carolina homestead exemption currently protects up to $56,150 of “the debtor’s aggregate interest . . . in real or personal property that the debtor . . . uses as a residence.” Judge Burris reasoned that Donald owned an interest in the trust, not the home, and that the trust itself was not real property where the debtor lived.
Across the country, bankruptcy courts have split on this issue, usually deciding the question based on the specific wording of the state’s homestead exemption law. That’s what Burris said she was doing.
In my view, however, Judge Burris overlooked the fact that the South Carolina homestead section protects “the debtor’s aggregate interest” in the home. Trust law generally recognizes that the beneficiary of a trust owns the beneficial or equitable title to the assets of the trust. Equitable title means the beneficiary is entitled to all the benefits of property, including its use and income, even though the trustee holds legal title. The beneficiary, not the trustee, is the real owner. Our homestead statute, unlike those of some states, does not limit the kinds of ownership interest that can be exempted. Clearly a beneficiary’s interest in living trust property, which is the real and meaningful ownership of the property, is a kind of interest the exemption is intended to protect.
In addition, there is no rational policy reason to deprive an owner of homestead protection simply because he has deeded his home to his own trust. A living trust is a proper legal method of estate planning, not a fraud on creditors, and those who use it do not deserve some special form of punishment.
The lesson of this case for debtors and their lawyers is to revoke any estate planning trust that holds a debtor’s property before filing bankruptcy. But since exemptions also protect property from creditors in state court collection procedures, the case also suggests that both lawyers and clients planning estates should hesitate before using a living trust as the basic estate planning instrument.