Most of the time everything you own is exempt, meaning it’s protected in a Chapter 7 bankruptcy. If not, Chapter 13 can usually protect it.
Our last blog post was about keeping or surrendering assets which are security on a secured debt—such as a vehicle on a vehicle loan, a home with a home mortgage, or a household appliance on a secured store credit card or contract.
Today we discuss protecting assets that are not encumbered by any debt. So these assets cannot be repossessed by any secured creditor. However, your creditors would have a right to even these unencumbered assets if an asset is not “exempt.”
Here’s what property exemptions are and how they protect you under a Chapter 7 “straight bankruptcy” and under a Chapter 13 “adjustment of debts.”
The Simple Principle
Choosing between Chapter 7 and 13 on the specific issue of protecting your possessions is based on a very straightforward principle. If everything you own and want to keep fits within the property exemptions that are available to you, you can file a Chapter 7 case and keep everything; otherwise you need the extra help of a Chapter 13 case.
Exemptions are a list of categories of assets, with each category usually assigned a maximum dollar amount, that you are allowed to keep protected from your creditors.
For example, if a vehicle exemption in the amount of $3,500 was available to you, and you owned a vehicle worth no more than that, a creditor that did not have a lien on your vehicle could not take that vehicle to pay the debt you owe it.
This hypothetical $3,500 amount protects not just to the entire value of a free and clear vehicle, but also that much in equity on a vehicle with a loan on it. For example if the vehicle was worth $12,000 but had a $9,000 loan on it, the $3,000 in equity in this vehicle would be protected. Again we are talking about this vehicle being protected from creditors other than the one with a loan and lien on it–see our last blog post about protecting this vehicle from its secured creditor.
The sensible idea behind property exemptions is that you should be able to retain at least a certain amount of possessions from your creditors so that you do not become destitute and a burden on society. The practical assumption is that financial rehabilitation is inhumanely difficult if you have nothing—no roof over your head, no car to get to work in, no furniture—upon which to rebuild your life.
State and Federal Exemptions
Before looking at how exemptions work in Chapter 7 and Chapter 13, let’s clear up something that is often a source of confusion. Each state has its own set of property exemptions used for bankruptcy and non-bankruptcy purposes. The federal bankruptcy law also contains its own set of exemptions. Which one do you use?
Depends what your state allows. Because of a compromise in the bankruptcy law resolving a conflict between states’ rights and federal power, each state is allowed to either require its bankruptcy-filing residents to use that state’s set of exemptions or to have a choice between those state exemptions and the federal ones.
So, in all states its residents can use their state’s exemptions, and in 19 states (plus the District of Columbia) residents also have the option of using the federal exemptions. These 19 states are Alaska, Arkansas, Connecticut, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.
Applying the Simple Principle
The simple principle we started with should make a little more sense now. If you live in any of the 31 states where you must use that state’s set of exemptions, you need to see if those exemptions cover everything you own and want to keep. And if you live in any of the specified 19 states plus Washington D. C., see if either your state’s exemptions or the federal ones in the Bankruptcy Code cover everything you own and want to keep.
Under Chapter 7
If the answer in either set of states is yes—if everything you own is exempt—you can file a Chapter 7 “liquidation” bankruptcy and nothing of yours would be liquidated. You would have a “no-asset” case, meaning that the trustee—an agent for all your creditors—would collect no assets from you to distribute to your creditors.
If you do own something that is not exempt but you want to keep, and you still want to file a Chapter 7 case, there is a possible option: the trustee may be willing to let you keep it by paying for the right to do so.
Take the example of the $3,500 vehicle exemption above. If you owned a vehicle worth $8,000 only $3,500 of it would be exempt, leaving the remaining amount of $4,500 unprotected. A trustee would likely accept payment of $4,500 from you and allow you to keep the vehicle, saving him or her the trouble of selling it.
The trustee would even likely accept somewhat less than $4,500 from you because he or she would have incurred some costs in selling your vehicle, which would have reduced the $2,500 in sale proceeds. So if the trustee would have had to pay $500 in fees to an auto auction to sell off the vehicle, you may only need to pay the net amount of $4,000 to keep the vehicle. The trustees may even accept monthly payments on that amount over the course of 10 or 12 months or so instead of a lump sum payment.
Either way, after receiving the $4,000 from you the trustee would divvy that up among your creditors, doing so according to a prioritization scheme laid out in the law.
Under Chapter 13
How does Chapter 13 protect a non-exempt asset that Chapter 7 can’t? Somewhat similarly as in the example immediately above, but in a way that would often give you much more control over the situation.
In a Chapter 13 case you have 3 to 5 years to pay the creditors at least as much as they would have received in a Chapter 7 case. So, using the above example in which you would have paid the trustee $4,000, under Chapter 13 your monthly payment plan would have to earmark at least $4,000 to the creditors over its 3 to 5 year span (as well as wall as perhaps more to satisfy some other special debts that are better paid under Chapter 13).
Not only would you likely have much longer to take care of that obligation under Chapter 13, you’d have more flexibility. Your payment plan could pay other more urgent creditors ahead of this $4,000, such as a home mortgage arrearage or back payments on child support.
And if you owe a special debt, like say $4,000 for income taxes owed to the IRS on a recent tax year, your Chapter 13 payments could all go to the taxes that you would have to pay anyway instead of to your other general creditors.
The same thing would happen in a Chapter 7 case—the IRS would be paid ahead of and here instead of any other creditors from the $4,000 you would have paid. But under Chapter 13 you would not only have so much more time to take care of that tax debt, thereby reducing your monthly payment, and more flexibility in paying other important creditors, you would also be protected from the IRS’s collection actions throughout 3-to-5-year payment plan.