If you’ve been hit by financial hardship, filing for bankruptcy can offer you a way out of crippling debt. Bankruptcy is a court proceeding that can allow businesses or individuals freedom from their debts while also providing creditors an opportunity for repayment.
However, before you make this move, it’s essential for you to understand how a bankruptcy will affect your assets. This article will offer information on what assets are protected in a bankruptcy and how bankruptcy exemptions work.
The first important decision in filing for personal bankruptcy is whether to file under Chapter 7 or Chapter 13. This choice will play a significant role in what assets you are able to keep.
Chapter 7. Sometimes called a “straight bankruptcy,” Chapter 7 is the most common type of bankruptcy proceeding. Under Chapter 7, qualifying individuals, partnerships, LLCs, or corporations can eliminate most of their unsecured debts (and some secured debts) through liquidation. When you liquidate assets, you make cash available to pay your creditors.
When you file for Chapter 7 bankruptcy, creditors are no longer able to garnish your wages, harass you with phone calls, or initiate lawsuits against you. However, Chapter 7 exemptions typically apply only to your legal residence, not to any property you own as an investment.
Chapter 13. Under Chapter 13, you can keep all your property, including your investment property, but you must pay your creditors a portion of what you owe according to a reorganized three- to five-year repayment plan.
The amount you must pay certain creditors under Chapter 13 depends on how much property you can exempt. Here’s are some examples of how it works:
The purpose of bankruptcy is not to strip you of everything you own. The courts understand that if you lose everything, the legal proceeding is at best counter-productive. There are both state and federal laws to protect some of your property from creditors even if you don’t file for bankruptcy.
However, you must claim your exemptions when filing your bankruptcy petition in order for them to be protected. And, as we have explained, the court handles exemptions differently depending on whether you file a Chapter 7 or a Chapter 13 petition.
Some states require you to use their list of state exemptions. Others allow you the option of choosing either its exemptions or the federal system’s set of exemptions. You cannot combine the two sets. The state laws you qualify to use depend on where you have lived over the past two years.
Bankruptcy law views property under the lens of necessity. Property that you can keep (exempt property) generally includes items that are deemed necessary for living and working purposes. Property that you have to give up (non-exempt) includes items that fall outside what the court deems the petitioner requires for living and working.
Under Chapter 7, exemptions typically apply only to your residence, not to any property you own as an investment. Investment real estate, including rental property, is generally not exempt.
Here are some typical examples of exempt property:
Here is a list of property that typically is not exempt:
Filing for bankruptcy is never an easy decision since it comes with long-term credit and financial consequences. If you own real estate investments, the decision is even more challenging.
However, many investors are facing unique challenges these days. If you think filing for bankruptcy might be the right decision for you, it’s wise to take the time to consider all the ramifications and consult a trusted legal and financial professional.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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