Good Reason to Delay Bankruptcy until Now: Time to Convert Non-Exempt Assets into Exempt Ones
One strategy to prevent the loss of asset value in bankruptcy is through very cautious conversion of unprotected assets into protected ones.
Most People Don’t Need Much Pre-Bankruptcy Planning
Today’s blog post follows up on the last one, which started by emphasizing that the majority of people filing bankruptcy don’t lose anything. They protect all they own through property exemptions provided by either state or federal law, or by the extra protection of Chapter 13.
But you can’t simply assume that everything you own is protected in bankruptcy. The exemption laws are much more complicated than they may seem at first, with the mixture of state and federal statutes, periodic amendments to those statutes, and state and federal appellate court decisions interpreting them.
The result is that assets that may be completely protected in one state can be unprotected if you happen to be in the state next door, or can be left unprotected by a change in the law.
As also emphasized in the last blog post, there is some risk involved in making changes to your assets during the period of time before filing bankruptcy. Simply put, ALL pre-bankruptcy planning should be done under the careful guidance of an experienced bankruptcy attorney.
Contributions of otherwise non-exempt assets into exempt retirement plans are generally respected and not challenged by the bankruptcy system, as long as the amounts are not egregiously large. There are limits to how much you can contribute based on the tax laws—annual contribution maximums, which can also shift based on your age and income. Talk to your bankruptcy attorney (and perhaps to a tax accountant) about the availability and appropriateness of contributions into an IRA, SEP IRA, 401(k), or Defined Benefit Plan.
Putting otherwise non-exempt funds into an exempt homestead is another relatively safe strategy. Some states have very modest homestead exemptions, while others are very generous—from a few thousand dollars to an unlimited amount in value or in equity.
If you own a home with value or equity well under the homestead exemption amount, and that home is in need of urgent repairs from deferred maintenance, it’s usually safe to make those repairs. This improves the home, presumably somewhat increasing its value but keeping it within the homestead exemption limit, and provides you a sounder, cheaper to maintain home into the future.
Even if you do not own and cannot buy a home, in most states the applicable homestead exemption laws cover leasehold interests. If you are in a month-to-month rental, then advance rental payments (from the funds acquired from the sale of non-exempt assets) paid to your landlord would be legally refundable to you, and thus could be seized by the bankruptcy trustee. But if instead you paid a lump sum for the right to rent your place for a certain period of time—a term of 6 or 12 months, for instance—and your payment was explicitly non-refundable, the value of that leasehold could likely be protected under the homestead exemption.
If you have relatively little in non-exempt assets to cover, it’s usually quite straightforward to use the proceeds from selling such non-exempt assets to buy needed exempt assets. You may well have deferred buying clothing, paying for vehicle maintenance and repairs, buying food for immediate and long-term use, filling up on your home heating fuel, and even topping off gasoline for your vehicle(s). Appropriate purchases of these could easily absorb and protect many hundreds or even several thousands of dollars.