How Do Bankruptcy Exemptions Work?

Exemptions are sets of laws that vary state to state, that exempt, protect or withhold a certain amount of property from creditors if a resident is sued. These exemptions are applied in bankruptcy cases. Bankruptcy cases may use federal exemptions or the state that the case is filed in may have “opted out” of federal exemptions, which means that the state’s own exemptions are used. Under the new bankruptcy laws, the choice of exemptions is more difficult than just looking at where the case is filed. It will depend on where the debtor has lived during the previous two or more years.

The value allowances or “exemptions” provided by the bankruptcy code apply to equity that someone has in an asset. The equity in an asset represents the true ownership value, or “liquidation value”, of the asset. It is the value of the asset that would belong to the someone if the asset was sold, after paying off any liens.

For example, if a vehicle is worth $5,000.00, and there is a lien against the vehicle for $5,000.00, there is no equity to exempt because the total value of the vehicle is offset by the debt against it.

If sold, the balance of the loan to the lien holder would have to be paid before the lien would be released, and in order to keep the vehicle the loan must also be paid. The creditor retains the right to repossess the vehicle upon default of the loan even after bankruptcy. A properly taken lien is not broken by a bankruptcy filing. The lien is the extra security that the lender took to make sure that the loan was going to be repaid no matter what, and if it wasn’t repaid they have the right to take the property and sell it.

If the vehicle is worth $5000.00 and there is no debt against it, then the owner must use an exemption to protect that equity in bankruptcy. There may be a motor vehicle exemption sufficient to keep it, or another exemption as allowed by law. The exemptions are specific to the state where the bankruptcy is filed and where the bankruptcy debtor has lived in the years before filing. If North Carolina exemptions are used, there is a $3,500.00 vehicle exemption and there may also be an additional $5,000.00 “wildcard” exemption depending on the specific bankruptcy case if it hasn’t already been used.

If exemptions don’t cover all of the equity that the bankruptcy debtor owns, the Chapter 7 trustee can take the property and sell it. The proceeds would go to pay as much of the debtor’s creditors’ claims as possible, after paying for administrative expenses of the Trustee.

In Chapter 7, debtors keep all their exempt assets, but turn over non-exempt assets to the court. If the property equity is worth more than the allowed exemption of the bankruptcy debtor, then only a part is exempt. In that case, a debtor must turn the whole asset over to the Chapter 7 trustee to be sold if the Trustee asks. The debtor is entitled to receive the value of the equity that was exempt from the proceeds of the sale. The trustee will sell the asset, pay the debtor his or her share and distribute the excess among the debtor’s creditors.

Many bankruptcy Chapter 7 trustees are willing to allow the debtor to “buy back” the excess value in the property if the debtor pays a fair value. Bankruptcy lawyers often help negotiate such deals with the Trustee.

In Chapter 13, the debtor would either have to pay in the non-exempt value to his creditors over time through the plan payments. The debtor can also sell the property and turn over the proceeds to the Chapter 13 trustee. Keeping non-exempt property is one of the key features of Chapter 13 that might cause someone to decide to file a Chapter 13 bankruptcy case instead of a Chapter 7 case.