What Assets Are Protected in Bankruptcy?

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.

Chapter 7 vs. Chapter 13

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:

• You must repay your creditors at least the value of your investment property. (This rule is intended to ensure creditors receive at least as much out of a Chapter 13 case as they would under Chapter 7.)
• You can avoid foreclosure by rolling a few missed payments on your investment property into your Chapter 13 repayment plan and pay it back over three to five years.
• You can request that the judge lower the amount you owe on certain types of investment real estate to its current value. However, the downside of this strategy, called a “cramdown,” is that you will have to pay back the entire new loan amount during the new three- to five-year repayment plan.

What Assets Qualify For Bankruptcy Exemptions?

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:

• Vehicles (up to a specific value)
• Clothing (that is reasonably necessary)
• Household goods and furnishings (that are reasonably necessary)
• Household appliances
• Jewelry (up to a specific value)
• Pensions
• A portion of home equity
• Tools necessary for work (up to a specific value)
• A portion of unpaid earned wages
• Public benefits, including Social Security, public assistance, and unemployment funds accumulated in a bank account)
• Any personal injury damages

Here is a list of property that typically is not exempt:

• Cash, bank accounts, stocks, bonds, and other investments
• Cars, trucks, or boats not needed for everyday transportation
• A second home or vacation home
• Expensive musical instruments (unless the debtor is a professional musician)
• Collections of art, jewelry, stamps, coins, and other valuable items
• Family heirlooms
• Expensive show dogs or racehorses (now you know why we used a photo of a horse with this article!)

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.

Photo by Marylou Fortier on Unsplash