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Help Choosing Bankruptcy Exemptions

Exemptions play a large part in bankruptcy and knowing what they are and how they work is important to your case. Although your attorney takes care of working out this part of your case, it’s with your help that you get the protection you need. Exemptions play a part in other legal areas but today we’re focusing primarily on exemptions related to bankruptcy.

Before you read the rest of this article, you’ll want to read my writeup on how bankruptcy exemptions work:

So what are exemptions?

Exemptions are simply laws that protect property from creditors and the trustee during a bankruptcy. Property that is “exempt” cannot be taken by the trustee or by unsecured creditors. Exemptions are only available to individuals. Businesses and corporations cannot claim bankruptcy exemptions. The stated purpose of exemption laws is to prevent harm that would befall the public interest if creditors could render debtors wards of the state. See In re Ballard, 238 B.R. 610 (Bankr. M.D. La. 1999).

Think of it this way, if creditors are allowed to take everything from a debtor in bankruptcy, the debtor would be like the destitute and naked man forced to wear a wooden barrel held up by a pair of attached suspenders. That isn’t very practical from a societal standpoint, so most federal and state exemption laws allow the debtor to keep property reasonably necessary for the welfare of the debtor and his family.

Exemption rules for separate states

Exemptions can vary widely between states. Most states exempt some equity in at least one personal vehicle, and every state has an exemption that protects equity in a home (called a “homestead exemption”).

For instance: the federal homestead exemption is $21,625; Alabama protects a mere $5,000 in home equity; Illinois residents can protect $15,000; Nevada residents can protect up to $550,000; and many Texas homeowners residents enjoy an unlimited homestead exemption.

As a result, some wrongdoers in the Enron scandal reportedly transferred assets into lavish homes built in Texas before they filed personal bankruptcy.

Largely due to the public outcry after certain Enron executives sought to shield their assets using homestead exemptions in bankruptcy, Section 522(p) was added to the Bankruptcy Code. This section states that a debtor may not exempt “any amount of interest” that was acquired in residential or homestead property within 1215 days (three years, four months) preceding the filing of the bankruptcy petition that exceeds in the aggregate $146,450 (which is adjusted periodically for inflation) in value.

In the end, the debtor’s homestead exemption is capped under Section 522(p) if the property was purchased within 1,215 days of the bankruptcy filing.

How long to exemptions last?

Exemptions last forever. Section 522(c) of the Bankruptcy Code makes it clear that once property is allowed as exempt in bankruptcy, it is beyond the reach of pre-petition creditors (there are a few exceptions to this exemption protection, including non-dischargeable taxes and domestic support obligations).

Suppose, for instance, that the debtor was found liable for an intentional tort – he burned down his neighbor’s house. The debt is determined non-dischargeable during his Chapter 7 bankruptcy, but his claim of exemption on his house was allowed. The house is forever beyond that judgment creditor’s reach.

Note that while exempt assets are protected from many significant non-dischargeable debts (such as those based in fraud or from a non-support claim from a divorce), post-petition assets, such as property acquired after the bankruptcy filing or wages not part of a Chapter 13 plan, are fair game.

Selecting exemption laws

The election and application of exemptions can be a decisive factor in obtaining a fresh financial start. Your bankruptcy attorney will guide the you through the complex exemption laws and ensure that assets are properly protected when the bankruptcy case is filed.

Very few individuals lose property in a Chapter 7 liquidation bankruptcy, but it is important to identify property that may be at risk prior to filing the case. In most cases there are legal options to sell, transfer, or surrender property that is not protected by legal exemptions.

Section 522 of the Bankruptcy Code allows the debtor to elect either federal exemptions or state exemptions to protect property, not both. However, the Bankruptcy Code also allows states to “opt out” of the federal exemptions and restrict debtors in these states to state bankruptcy exemptions only. See Section 522(b)(2).

Alaska, Arkansas, Connecticut, District of Columbia, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Pennsylvania, Puerto Rico, Rhode Island, Texas, Vermont, Virgin Islands, Washington, Wisconsin and, most recently, Oregon all allow debtors to use either state exemptions or the federal exemptions contained in the Bankruptcy Code.

The remaining states have “opted out” of the federal bankruptcy exemptions and instead force residents to use its own set of state exemptions.

Federal bankruptcy exemptions are listed in the federal Bankruptcy Code and allow the debtor to protect a certain amount of equity in various assets, such as the homestead exemption, the automobile exemption, etc. Whether the debtor is able to choose a particular state’s exemption laws depends on the domicile of the debtor.

The debtor’s domicile is where the debtor permanently resides. However, in an effort to curb “abuse,” the Bankruptcy Code decides where the debtor is domiciled when the debtor has recently moved through a two part test:

  • The 730 Day Rule: when the debtor has been continuously domiciled in a state for 73
    0 days (2 years) before filing bankruptcy, the Bankruptcy Code states that the debtor applies that state’s exemptions or the federal exemptions (if allowed).
  • The 180 Day Rule: if the debtor was not domiciled in the same state for two years, then the debtor must use the exemptions of the state where he was domiciled for the greater portion of the 6 months prior to the two years preceding your bankruptcy.

To illustrate, suppose a debtor is domiciled in Texas from January 1, 2009 to January 1, 2011 (2 years), and then moved to Nevada; on January 1, 2012, the debtor files bankruptcy in Nevada. Even though the debtor lived in Nevada for twelve months, he must use the exemption laws of Texas.

Why? Because he was not domiciled in Nevada for a full two years (the 730 Day Rule), and for the six months prior to the two years preceding the bankruptcy filing the debtor was domiciled in Texas (July 1, 2009 through December 31, 2009).

So in the end, and what you can take from this information is that for the most part you’re protected from losing everything you own, but you need the help of an attorney who specialized in bankruptcy to help you get the full protection you require.