BANKRUPTCY EXEMPTIONS - WHAT ARE THEY?
This legal guide explains what bankruptcy exemptions are and how we use them to protect assets in bankruptcy.
EXEMPT VS. NON-EXEMPT PROPERTYIn bankruptcy we use "exemptions" to protect assets. There are state exemptions and also a set of federal exemptions (found in Section 522 of the Bankruptcy Code). Some states use their own exemptions, some use federal exemptions, and some use both state and federal exemptions. Here in California we have two sets of exemptions to choose from, both found in the California Code of Civil Procedure. The 703 series, found in CCP Section 703, has a generous wildcard exemption (also called "the grubsteak") that is currently worth a total of $30,825 which can be used to protect any property. The 704 series, found in CCP Section 704, does not have a wildcard exemption but instead has a generous homestead exemption which can be used to protect equity in the home. The current amount of the homestead exemption is between $300,000 and $600,000, depending on what the average sales price is for a single family home in the county where the property is located. This new homestead exemption went into effect in January of 2021, replacing the previously used set of three different homestead exemption figures that were chose from based on certain factors.
So, in California we have two sets of exemptions that can be used to protect assets in bankruptcy, and the set of California exemptions we choose would be the set that best affords the Debtor the ability to protect their assets.
Which Exemptions Apply?Section 522(b)(3)(A) of the Bankruptcy Code provides that Debtors cannot use their state's exemption scheme unless they have resided in the state for the entire two year period which immediately precedes the date of filing bankruptcy. If the Debtor has lived in their state for the full two years before the case is filed, they use that state's exemption scheme. If the Debtor has not lived in the state where they are filing bankruptcy for the full two years before filing, then the rule is that you must use the exemption scheme for the state in which the Debtor lived the majority of the 180 days immediately preceding the 2 year period. So then you must look to that state's exemption scheme to determine whether that's state's exemptions are required or the federal exemptions. (Some states limit their state exemptions only to residents so since the Debtor no longer lives there, they would then need to use the federal exemptions instead)
What Happens to Non-Exempt Property In Chapter 7?In a Chapter 7, non-exempt property can be liquidated by the Chapter 7 Trustee and the proceeds used to pay the creditors in order of priority. Bear in mind that the Trustee will not choose to liquidate all non-exempt property. If property is of minimal value or will be cumbersome or costly to liquidate, the Trustee will be disinclined to spend the time and resources liquidating. Bear in mind, however, that there is a trend among Chapter 7 Trustees in conducting shortsales of underwater properties in order to "carve out" a portion of the proceeds to benefit the creditors of the estate. When planning how to use the exemptions, keep in mind the Trustee's costs of liquidating. If the asset is cash, there are no costs involved. The Trustee will make a demand for payment and the money is turned over. If the asset is a car, however, the Trustee will usually sell the car at a public auction for which there are significant costs. If it would cost the Trustee 10% of a car's value to liquidate it, this can be factored into the amount of equity needed to be exempted by the Debtor to keep it from being sold. For real estate, there are costs of sale, and the bankruptcy Trustee must consider that 6% of the real estate value is allocated to costs of sale when determining whether there is any non-exempt equity.
What are the Debtor's Options With Regard to Non-Exempt Property?If there are non-exempt assets, the Debtor has a few choices: 1) Proceed with the Chapter 7 filing with the understanding that such assets may be liquidated by the bankruptcy with the proceeds going to pay their creditors in order of priority. This may be a good way to ensure non-dischargable tax debt is taken care of since it will have priority over general unsecured creditor claims. 2) Plan the bankruptcy filing over time to the extent possible to provide for allowable liquidation of non-exempt assets or conversion of non-exempt assets into exempt assets. There are substantial limitations to this which are discussed in Section VIII. 3) If the Debtor is eligible, they can file a Chapter 13 instead. The non-exempt assets will not be liquidated so long as the Debtor's Chapter 13 Plan provides for payment to the creditors in the amounts they would have received in a Chapter 7 case had the property been liquidated.