31 May Surrendering Rental Property in Chapter 7 or Chapter 13 Bankruptcy
Because of the new “means test” forms created as part of the 2005 Bankruptcy Reform Act, rental property which is to be surrendered in bankruptcy can be problematic. Prior to the law change, it was common for owners of rental property with no equity, and which the owner intended to surrender, to keep payments from tenants, without making payments on the mortgages on the rental property, during the months before and after the owner’s bankruptcy filing. The property would then go through foreclosure, and any claim against the property owner for a mortgage deficiency would be discharged. The owner could often pocket a fair sum of cash this way, with little fear of any negative consequence.
The increased financial reporting requirements contained in the Bankruptcy Reform Act made this difficult or, in many cases, impossible. Lines 3 and 4 of chapter 13’s Form B22C, and Lines 4 and 5 of chapter 7’s Form B22A (the means test form), require that a bankruptcy debtor report the gross receipts from any business, including rental property. Expenses such as mortgage payments on rental property are then deducted from gross receipts, resulting in a net profit or loss. However, losses cannot be deducted from other income, such as from wages, and only expenses that were actually paid can be deducted from gross receipts.
For rental property owners whose debts are not primarily business debts, and who therefore are subject to the means test’s income and expense analysis, not paying mortgage payments on rental property in the months before a bankruptcy filing can result in means test income which is too high. This could rule out chapter 7, or it could lead to a large and burdensome chapter 13 payment. Even rental property owners whose debts are primarity business debts, and who therefore are not subject to the means test, can experience a problem with excessive means test income, if they reside in a court district which requires all debtors to complete the means test form.
For many rental property owners, especially those who own only one or two properties of modest value, not paying mortgage payments in the months before a bankruptcy filing simply isn’t an option.
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