10 Nov Exemptions: What They Are, And Why They Matter
When you file bankruptcy under chapter 7 or 13, you also file a list of property you are claiming is “exempt” (this important piece of paper is called Schedule C). When property you own is exempt, that means you get to keep it, even though you’ve filed bankruptcy. To say it another way, when property you own is not exempt, you lose it to the trustee of your chapter 7 case, who then sells it and pays the money to your unsecured creditors. In a chapter 13, instead of losing the item, the non-exempt value increases the amount of your monthly plan payment. This means you need to know what property you own is exempt before you actually file a bankruptcy case.
“Property” you own means all property, not just real estate, which you own on the date of filing the bankruptcy. This term includes real estate, motor vehicles, furniture, jewelry, money, bank accounts, IRA accounts, pensions and 401(k) accounts, debts owed to you, lawsuits you could file against someone, inheritances you are actually waiting for now because someone has already died, patents, copyrights, shares of stock, fishing tackle, bicycles, and just about anything else that you own somehow, in some way, tangible or intangible. How can we determine if it’s exempt?
Let’s use your furniture as an example. Suppose the fair market value of your furniture, Kool-Aid stains and all, is $4,000 if you were to offer it for sale. The federal bankruptcy exemptions say that you can claim up to $10,775 worth of household goods as exempt. That means your furniture is exempt and you won’t lose it in a bankruptcy case. Great!
But wait, let’s move on to your 2005 Chrysler minivan, which has a bank loan against it of $17,000. It has fair market value of $17,500, and the federal bankruptcy exemptions only allow you to claim a motor vehicle exempt up to $3,225. Isn’t this a problem? The Chrysler minivan is worth way more than the $3,225 exemption limit, so doesn’t this mean it will be lost in a bankruptcy? No! The exemptions apply to your equity interest in property subject to a loan. For purposes of exemptions, the property’s value which must be exempted is the value of your interest in the property, which means the property’s value minus the loan balance. The Chrysler minivan is worth $17,500, but after subtracting the loan balance of $17,000, we are left with a paltry $500 for your equity interest in the minivan. This $500 is what must be claimed exempt, not the vehicle’s actual value of $17,500. The minivan’s $500 equity fits nicely within the motor vehicle exemption limit of $3,225. Therefore the Chrysler minivan is exempt even though it is worth much more than the exemption amount for motor vehicles.
Alright, what if you own a 1997 Ford Contour, with no loan against it, worth $4,000? This will be small problem, a $775 problem to be exact. The Ford is worth $775 more than the exemption amount of $3,225, and there is no loan to reduce its equity interest, unlike in the example in the paragraph above. You must pay the chapter 7 trustee $775 if you want to keep it. If you can’t pay, the trustee will sell it and give $3,225 to you, keeping the surplus to pay your creditors. In a chapter 13, the non-exempt $775 means you have to pay that much more in payments in your chapter 13 plan.
This anaysis applies to homes as well. If your home is worth $200,000 and the mortgage balance is $180,000, there is only $20,000 worth of equity which must be exempted. Thankfully, the federal bankruptcy law allows an exemption for your home up to a limit of $20,200. Therefore your home is exempt. However, if you owned a home worth $200,000 with no mortgage against it, that would be a serious problem (unless you live in a state with a large state law home exemption). The non-exempt equity would be $179,800, an impossible loss for most persons to contemplate. There are usually solutions to such a problem, but these are beyond the scope of this article.
The examples given above demonstrate in a basic way how exemptions work in bankruptcy, but note that other exemptions are sometimes available, such as the federal bankruptcy law’s “wildcard” exemption, which is $11,200. This would apply in the Ford Contour example given above, fully protecting it, as long as the “wildcard” exemption hadn’t yet been used up on some other asset.
The exemptions establish what property, and how much of it, you get to keep in a chapter 7 case; they establish indirectly how much your monthly payment must be in some chapter 13 cases. It’s important to understand that exemptions must be applied to the fair market value of your property, after deductions for outstanding loans or mortgages against that property. For most persons, all your property will be exempt. Even if that isn’t true for you, your bankruptcy lawyer can explain how to address that circumstance, either in bankruptcy or with a non-bankruptcy solution to the problem.
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