Chapter 7 Liquidation
In a Chapter 7 bankruptcy, the court must be notified if you inherit any property within 180 days of filing for bankruptcy. The court will include these funds in your bankruptcy estate, and any non-exempt assets would be subject to seizure and liquidation by the court-appointed bankruptcy trustee to repay your creditors. Also, you must include any inheritance as income for the bankruptcy means test, which figures into determining your eligibility for Chapter 7 protection. Some trusts may be exempted under bankruptcy law. For example, in California, a trust that becomes irrevocable on the death of the grantor stays outside of the bankruptcy estate, as long as you inherit from it after you've filed the bankruptcy petition. One example of this would be a spendthrift trust, in which the trustee strictly controls payouts to the beneficiary.
Chapter 13 Repayments
If you have enough income to partially repay your creditors, or you fail the Chapter 7 means test, you can file for a Chapter 13 bankruptcy. The trustee will set up a plan for partial repayment of your debts, based on your income and assets, over a period of three to five years. If you receive an inheritance while the plan is in effect, the trustee can include the property in a calculation of your monthly payments to creditors. If you fail to make these payments, the court can dismiss the bankruptcy, putting you right back where you started, with all debts again legally valid and collectible.
Federal law treats certain property as outside the trustee's control. This means you can keep certain assets -- known as "exempt" assets -- even if you file for Chapter 7 bankruptcy. If you've filed for Chapter 13, the trustee includes the value of your non-exempt property in calculating your monthly payment. On its own, an inheritance is not necessarily exempt under bankruptcy laws, but you may be able to claim an exemption for certain types of inherited property. There are both federal exemptions and state exemptions, and in most states you must choose one or the other. California requires you to select one of two separate state exemption schedules, known informally as Set 1 and Set 2.
California Exemption Schedules
The California Set 1 exemptions as of April 2013 include up to $5,100 in one or more motor vehicles; $25,575 in your homestead; $7,625 in tools of trade; $1,525 in jewelry; and an unlimited exemption for household goods, as long as no one item exceeds $650. In addition, you may claim a "wild card" exemption for any property up to $1,350, plus any unused portion of the homestead exemption. If you do not have a homestead, that means you can extend the wildcard exemption to cover up to $26,925 in cash or other assets. California's Set 2 exemptions include $2,900 in motor vehicles, $7,625 in jewelry, $7,625 in tools of trade, any reasonable and necessary furnishings, and $75,000 in homestead equity if you're single and $100,000 if you're married. There's no provision for a wild card exemption in this schedule. Although appellate court decisions vary across jurisdictions, in California, assets you receive as part of an inherited IRA are exempt.