Most of the time you get to keep everything you own when you file bankruptcy. It’s all covered by property exemptions. But not always.
Here’s how property exemptions work in bankruptcy to protect what you own:
#1. The basic rule:
You get to keep everything you own as long as it all fits within “property exemptions.” These are categories of assets—each usually with a maximum dollar amount—that you are allowed to have. See Section 522 of the U.S. Bankruptcy Code.
But there is a lot more to this than just matching assets to exemptions. What is and is not covered by some exemption categories is not always clear. In many states you get to choose between a federal and a state set of exemptions. You have to know which state’s exemptions apply to you if you’ve moved recently. Applying these laws often requires knowing how the state and federal statutes have been interpreted in court decisions, and/or how the local trustees and judges are enforcing them.
#2. Federal and state sets of exemptions:
Bankruptcy law is federal law, as the U.S. Constitution make clear. See Article I, Section 8, Clause 4 of the Constitution. But Congress has exercised its power by giving each state a choice. Each state can decide whether to allow its residents to use a federal set of exemptions in the Bankruptcy Code for bankruptcies filed in that state, or instead require them to use of a set of exemptions created by the state.
So you have to first know which set of exemptions you are allowed to use. And then, if you are allowed to use either one you need to know which of the two sets would be better for you.
#3. You have to qualify for your state’s exemptions by living there long enough:
Which exemptions you can use can depends on how long you’ve lived in the state you’re living in now. You can use the exemptions available in your state only if you’ve been “domiciled” there for two full years before filing bankruptcy. (“Domiciled” basically means living there during that time, but that can also depend on various factors.)
Otherwise you have to use the set of exemptions available to residents of the state you were “domiciled” in during the 6-month period immediately before those two years.
The exemption laws in your prior state may be better or worse than in your new state. Sometimes significantly so. So, sometimes it makes sense to hurry the filing of your case to take advantage of your prior state’s exemptions. Other times it makes sense to delay filing to take advantage of your new state’s exemptions.
#4. The importance of pre-bankruptcy planning:
You can often protect assets not covered by the available exemptions with wise pre-bankruptcy planning. This is one of the important reasons to meet with a competent bankruptcy lawyer, and to do so as soon as possible.
Pre-bankruptcy asset-protection plans often need a relatively long period of time for them to be effective. So it’s crucial that you get thorough legal advice well before creditors’ actions force you into filing bankruptcy. Doing so can make the difference in being able to protect what’s important to you.
#5. Paying to keep your own asset:
Although it may feel odd, you can often pay for the right to keep an otherwise unprotected asset. Chapter 7 may otherwise definitely be your best option, but you don’t want to lose something that’s not exempt. Paying to keep it may be better than spending 3 to 5 years in a Chapter 13 case to protect it.
Most Chapter 7 trustees are willing to accept your payment of the fair market value of the item, and sometimes less. That’s because you paying them can save the trustee the costs associated with selling that item. So the trustee just needs to receive the net amount he or she would receive after paying the costs from a hypothetical sale. For example, if you have a non-exempt boat you’d like to keep, you could pay a projected sale amount minus a boat broker’s sales commission, transport and storage/dockage fees, and such.
Also, many trustees are willing to accept your monthly installment payments to buy back a non-exempt asset. A trustee is willing to take some risk because you are at his or her mercy. If you don’t pay the agreed payments you will lose your ability to discharge (write off) your debts.