Valuing Real Property In Bankruptcy
May a debtor may deduct "costs of sale" when valuating property upon bankruptcy filing? A frequent question that comes up when dealing with clients interested in filing bankruptcy is whether the costs associated with the sale of their real property (house) can be deducted from the value of the property. If it could, then they would have less equity in the house and could either protect it with an exemption or the trustee might not attempt to liquidate it as it would not generate assets for the creditors. As with many such questions, part of that is true and part is not. A debtor must list the current market value of the property on the bankruptcy schedules without deducting cost of sale. Thus, if a creditor has a secured claim on the property, it is secured to the extent of the current market value. This is particularly relevant where there is a first and a second mortgage and the debtor desires to strip the second mortgage, asserting that there is no equity in the property for it to attach. However, so long as there is one dollar for it to attach to, as determined by the properties current market value, then it attaches. The Bankruptcy Code states that "an allowed claim of a creditor secured by a lien on property in which the estate has an interest...is a secured claim to the extent of the value of such creditor's interest in the estate's interest in such property....Such value shall be determined in light of the purpose of the valuation and of the proposed disposition or use of such property...." 11 U.S.C. 506 (a)(1). The courts have followed this line of thinking. A ninth circuit case from 1992 (vacated on other grounds) found that it was illogical to "allow the debtor to keep the home but value the secured portion based upon a hypothetical sale of the residence." Lomas Mortgage USA v. Wiese, 980 F.2d 1279 (9th Cir.1992). This view has been adopted by numerous courts, including the recent In re Cook, 415 B.R. 529 Bkrtcy.D.Kan.,2009. Of course, this does not mean that such a lien cannot be crammed down, but that is a topic for another day. If the property is to be liquidated in bankruptcy, the trustee will take into account the liquidation value of the property and costs of sale will become relevant. However, where the debtor plans to retain the property, the current market value must be reported on the schedules without deductions, and the secured or unsecured status of lien holders will be determined accordingly.