Fifth Circuit Finds That Chapter 7 Debtors’ IRA Proceeds Not Timely Reinvested Lose Exempt Status

The Headline:

In In re Hawk, __ F.3d __, 2017 WL 3048605 (5th Cir. 2017), the Fifth Circuit held that despite having timely claimed an exemption in their IRA account, the Chapter 7 debtors’ post-petition liquidation of that account rendered the proceeds non-exempt when they were not reinvested within the sixty day time period allowed under the Texas Property Code. The court ruled that despite the so-called “snapshot rule” and the lack of a timely objection to the exemption claim, the IRA exemption under Texas law was predicated upon the entirety of that law, which conditioned the exempt status of IRA proceeds upon a timely rollover within sixty days.

The Facts (Simplified):

The debtors sought Chapter 7 relief.  They claimed an exemption for funds held in an Individual Retirement Account (IRA) under Section 42.0021 of the Texas Property Code. No timely objection was filed under Bankruptcy Rule 4003(b)(1). The Chapter 7 Trustee filed a no asset report.

In subsequent discovery in an adversary proceeding, it was discovered that approximately $133,000.00 was withdrawn from the debtors’ IRA, post-petition, and after the objection deadline had passed. The Chapter 7 Trustee sought the turnover of those proceeds, asserting that those proceeds became property of the bankruptcy estate.

As explained below, Judge Bohm of the Southern District ruled that the funds lost their exempt status under Texas law because the debtors “did not roll them over to another individual retirement account within sixty days.”  See, In re Hawk, 524 BR 706 (Bankr. S.D. Tex. 2015) (Bohm, J.). The District Court affirmed, as did the Fifth Circuit.

The Court’s Analysis (or what is actually included in the “snapshot” taken on the petition date?):

The Texas Property Code provides a broad exemption for qualified funds held in an IRA. Texas Property Code §42.0021. Proceeds of the IRA are even protected under Section 42.0021, provided that they are rolled into another exempt retirement account within sixty days of the distribution.  Id. §42.0021(c). 

Under the Fifth Circuit analysis, when funds are withdrawn from an IRA, they evolve from “an unconditionally exempted interest in the amounts held in the retirement account to a conditionally exempted interest in the amounts distributed from the retirement account.”  In re Hawk at ___ (emphasis added). This requirement “is inextricably intertwined with the exemption the state has chosen to provide.”  Id. at ___, quoting In re Zibman, 268 F.3d 298, 304 (5th Cir. 2001).  Therefore, the theory goes, the “snapshot” of the IRA as of the petition date includes subsequent disposition of the IRA/proceeds while the bankruptcy was pending.

The court followed a similar analysis it had applied in previous cases regarding the six month rollover protection for proceeds of a Texas homestead. See, In re Frost, 744 F.3d 384 (5th Cir. 2014) and In re Zibman, 268 F.3d 298, 304 (5th Cir. 2001). In Frost, the court held that when a debtor sold his homestead, post-petition, but while the case (in Chapter 13) was still pending, the proceeds lost their exempt character when they were not reinvested in another homestead within six months.  This applied a somewhat “dynamic” application of the “snapshot rule.”

Applying these principles, the court found that the lack of a timely objection to the exemption claim was a non-issue. Additionally, the court disregarded any argument that its reasoning was inapplicable in a Chapter 7 context (as opposed to a Chapter 13). 

Our Take:

From a debtor’s perspective, one might argue that this renders the so-called snapshot rule not so much of a snapshot (and Frost, for example, has been criticized by commentators). On the other hand, this approach is quite similar to the Fifth Circuit’s earlier rulings with respect to the proceeds of a Texas homestead. So, right or wrong, this result should come as no surprise.  Additionally, this holistic view of the exemption statute does make sense in the context of taking the good with the bad in terms of the exemption statute. Again, the Fifth Circuit’s view is that in the context of exemptions, it is the asset itself (the homestead, the retirement account, etc.) and not necessarily its value that is exempt.  When those exempt assets are liquidated, Texas law does provide some limited protection for a set period of time, but that protection is indeed conditioned upon reinvestment of those proceeds in a similar asset.

What is less than clear is when a Chapter 7 debtor, post-petition and post-discharge, is “in the clear,” so to speak, to sell a homestead or pull proceeds from a retirement account.  Arguably, this would occur after the bankruptcy case has closed, but this was not addressed in Hawk.

Also unresolved:  the tension between state law (the source of this exemption) and federal bankruptcy law, which provides the exemption mechanism in a bankruptcy case. In the meantime, at least in the Fifth Circuit, the “snapshot rule” has become somewhat of a “motion picture rule.” 

*Roger Cox, a shareholder resident in Underwood’s Amarillo office, is Board Certified in Business Bankruptcy Law, Commercial Real Estate Law, and Farm & Ranch Real Estate Law by the Texas Board of Legal Specialization. Mr. Cox is the author of Cox’s Texas Creditors Rights Laws Annotated (Thomson Reuters 2017), and a former contributor to the SMU Law Review

This article is for general and academic information only and is not intended as legal advice or as a specific position asserted on behalf of any existing or future client of the firm.

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