Debtor Who Took Distribution from IRA to Purchase Home within 90 Days of Filing Bankruptcy Could Protect IRA from Trustee

Debtor Who Took Distribution from IRA to Purchase Home within 90 Days of Filing Bankruptcy Could Protect IRA from Trustee

This matter is before the Court on the objection filed by the Chapter 13 Trustee to the Debtor’s claim of an exemption in an IRA with Charles Schwab in the approximate amount of $690,000. The Trustee contends that the exemption should be disallowed because the IRA lost its eligibility as a qualified plan under applicable provisions of the Internal Revenue Code based on the Debtor’s pre-petition conduct.

The Trustee also objects to confirmation of the Debtor’s Chapter 13 plan and seeks to have the case reconverted to Chapter 7 on the same basis as the exemption objection. The Trustee contends that the plan does not satisfy Section 1325(a)(4) of the Bankruptcy Code because it does not pay creditors as much as they would receive in a Chapter 7 case. However, his “best interest of creditors objection” is tied solely to the exemption of the IRA preventing those funds from being distributed to creditors.

The Debtor proposed a plan that pays 1% to unsecured creditors. If the Debtor’s exemption is disallowed, it would result in a 100% payout to unsecured creditors since the value of the IRA is more than five times the amount of his unsecured debt. In short, the decision regarding the validity of the exemption will not only govern the exemption objection but also whether the Debtor’s Chapter 13 plan can be confirmed. Likewise, the Court’s decision may effectively dictate the result of the motion to convert since disallowance of the exemption could make any Chapter 13 plan impossible to confirm in light of the Debtor’s limited income outside of the retirement money.

One thing is clear from a review of the applicable statutes, case law, and other authority: there is no overriding bankruptcy principle at issue here. Rather, this is simply a matter of whether the Debtor’s IRA is no longer a qualified account under IRS rules. If it is a qualified plan, then it does not matter how large the IRA account is or how small the distribution to unsecured creditors would be. In other words, the potential effect on unsecured creditors is irrelevant, and the Debtor either has a qualified IRA or he does not.

Although the Debtor testified during the hearing on this matter, all relevant facts have been formally stipulated or are not in dispute. The Debtor, who is above the age of 59½, has been the sole owner of the Charles Schwab IRA since at least early 2016. The IRS has approved the IRA account as one that is proper as to form, but certain transactions involving the Debtor’s IRA lead the Trustee to contend that the IRA lost its qualified status shortly before the bankruptcy.

On March 15, 2016, the Debtor withdrew $327,978.13 from the IRA. On that same date, the Debtor used the withdrawn funds to purchase a house jointly with his spouse and titled it in both of their names. The real estate was never placed into the IRA or any other retirement account, but rather remained jointly titled in the names of the individuals.

About one week later, on March 21, 2016, the Debtor received approval from BankTennessee for a $252,000 mortgage based on placing a lien on the house purchased with funds contributed from the IRA. The BankTennessee loan was funded on or before May 10, 2016. On that date, the Debtor deposited $246,945 back into the same IRA from the proceeds of the mortgage loan. He subsequently paid taxes, as a retirement distribution, on the portion of the funds withdrawn from the IRA but not deposited back into the IRA.

On August 5, 2016, less than three months after the transaction involving the mortgage and deposit of funds back into the IRA, the Debtor filed a voluntary petition under Chapter 7. The Debtor’s original schedules did not list the IRA nor claim an exemption. Nevertheless, the Chapter 7 Trustee became aware of the existence of the IRA and raised issues about it, prompting the Debtor to convert the bankruptcy to a Chapter 13 case. The conversion order was entered on August 3, 2017. The Debtor listed the IRA on the conversion schedules, showing an account value of $691,345.55, and the Debtor claimed an exemption for the entire amount.

The Debtor has no pre-petition priority debt and has unsecured debt totaling approximately $127,700, based on the scheduled debts and proofs of claim filed up to the time of the exemption hearing. Therefore, all debts would be paid in full using only a portion of the IRA, if it is not exempt.

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