Security Deposits and Bankruptcy
Security Deposits in Bankruptcy
When filing for bankruptcy protection, all assets must be listed on the petition including landlord security deposits. 11 USC 541. Although the security deposit is not in the possession of the debtor, the deposit legally belongs to the renter and must be returned unless the landlord is allowed by state law to retain portions of the deposit to cover damages to the property and back rent. What portion of a security deposit may be retained by a landlord and for what reasons vary from state to state.
Because a security deposit is an asset of the estate subject to being taken by a bankruptcy trustee, it should be claimed as exempt when possible. Whether a security deposit is exempt under state law, varies from state to state. If the debtor resides in a state that allows use of the federal bankruptcy exemptions, the deposit can be exempted under the “wildcard” exemption. 11 USC 522(d)(5). However, if the debtor resides in a state that does not provide an exemption for security deposits or if the debtor has no room under the wildcard exemption, the trustee could take steps to recover the security deposit to pay creditors. Although this is an option, in practice it rarely occurs.
A bankruptcy trustee has no greater rights to an asset than the debtor. Meaning, the trustee only obtains whatever right the debtor had to the security deposit at the time the bankruptcy petition was filed. In most cases, the debtor has no right to the security deposit until the end of the rental agreement. Thus, unless the estate is held open until the end of the rental agreement, the trustee will not obtain a right to the deposit. Furthermore, the amount of security deposit returned will depend on whether the landlord has legal cause to retain a portion of all of the deposit. Due to these limitations, even if not covered by an exemption it is unlikely a trustee will take action to recover a security deposit barring extraordinary circumstances. Regardless, if a security deposit can be claimed as exempt is advisable to do so and avoid even the possibility that the trustee will attempt to recover the deposit.
