Exemption Laws Protect Your Property From Creditors Inside and Outside of Bankruptcy
When a bankruptcy case is filed, a bankruptcy estate is created which is comprised all of the property of the debtor. Exemption laws provide the rules for determining whether that property will be distributed to creditors or whether you’ll be able to keep it. In order to better grasp the concept, picture a warehouse full of all of your stuff. At the front door is a card table with different name tags scattered across it. Each name tag lists a type of property with an associated dollar value. For example, one tag says “car $3,000″ another says “house $50,000.”
You are permitted to take the name tags and stick them on all of the stuff you’d like to protect from the trustee. If you run out of name tags and there is still stuff left over, or the dollar value on the tag is insufficient to cover the value of your property, it is considered “non-exempt” and could be vulnerable to the trustee. Exemption laws work this way both inside and outside of bankruptcy. In bankruptcy, you are protecting property from the trustee, outside of bankruptcy, you are protecting property from a judgment creditor.
In chapter 7 bankruptcy, exemption laws dictate what property you can keep and what property is subject to sale by the trustee. In chapter 13 bankruptcy, the exemption status of your property will be a factor in determining the size of your monthly payment to unsecured creditors. It is because of bankruptcy exemptions that many consumers are able to eliminate debt in bankruptcy without losing any of their stuff. In most cases, the available exemption laws are sufficient to cover all of your property.
Exemption Laws Vary by State
Each state has a set of bankruptcy exemptions as does the federal system created by Congress. In addition, certain non-bankruptcy exemptions protect certain types of property (such as IRAs) no matter which set of exemption laws apply. Although most states require debtors to use their exemptions, some allow debtors to choose between state and federal exemptions. Choosing between exemption regimes can have a big impact on the amount and type of property a debtor can protect. For example, the New Jersey bankruptcy exemptions do not contain a homestead exemption. As a result, debtors in New Jersey are forced to utilize federal bankruptcy laws in order to shield home equity from the trustee.
Arizona is what is known as an “opt-out” state, meaning consumers who file bankruptcy in Arizona must use AZ exemptions. To illustrate the concept of utilizing an exemption, we’ll focus for a moment on the Arizona homestead exemption which allows homeowners to protect up to $150,000 of home equity. let’s say John and Jane file a joint bankruptcy petition and list an Arizona home, valued at $350,000, in their bankruptcy schedules. The home is encumbered by a mortgage of $300,000, meaning John and Jane have $50,000 in home equity. In this example, John and Jane’s home is exempt and is not subject to sale by the bankruptcy trustee because the amount of their home equity ($50,000) is less than the limit of the Arizona homestead exemption ($150,000).
To continue with the example above, if John and Jane owned their home outright with no mortgage, $200,000 of its value would be non-exempt and it is very likely the trustee would try to sell the property and distribute the proceeds to the couple’s creditors.
Sale of Property Doesn’t Defeat an Exemption
Even in the event of a sale, you’ll be receiving a check. Why? Your creditors are only entitled to your non-exempt equity. Remember, your exempt property value is off limits.
Were John and Jane’s property sold, they would receive a check for $150,000. The $150,000 representing the amount of the Arizona homestead exemption. Only the non-exempt equity is vulnerable to creditors and a sale does not defeat the exemption.
The Bottom Line
If you’re being pursued by a creditor or are considering bankruptcy, meet with an attorney to learn more about your state’s exemption laws. A good attorney will be able to advise you what property, if any, is vulnerable and how best to protect it. When it comes time to file your case, review Schedule C very carefully and be sure to ask questions if something doesn’t look right. Schedule C of your bankruptcy filing is where your attorney will designate your property as exempt and list the the exemption laws that apply to each type of property.
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