When considering Chapter 7 bankruptcy, most people want to know if they can keep their property. The short answer is maybe. Chapter 7 bankruptcy wipes out many qualifying debts, but there is a catch—if you own too much property, the bankruptcy trustee can sell some of it and pay the proceeds to your creditors.
So how much property can you keep? The answer depends on "exemptions"—state laws that tell you what you're allowed to protect in Chapter 7 and 13 bankruptcy.
When you file for Chapter 7 bankruptcy, almost all of your property becomes property of the bankruptcy estate. That doesn't mean you lose everything. The purpose of bankruptcy is to provide people with a fresh start—and part of that fresh start is keeping the things you need to hold down a household and job. Bankruptcy exemptions allow you to keep the things you'll need to work and live, such as furniture, dishes, clothing, and a car.
How much property you can exempt differs depending on which state you live in because each state has a set of exemption laws (federal exemptions exist, too, and you might be able to choose between the state and federal exemptions).
Example. If you own a car worth $5,000 and your state allows a $6,000 car exemption, then you can keep your vehicle. However, if you live in a state that only allows a $2,000 car exemption (assuming no other exemptions are applicable), then the bankruptcy trustee may take your car and sell it. From the proceeds of the sale, the trustee will pay you the exemption amount of $2,000 and distribute the rest among your creditors.
If you own a house, car, or expensive household furnishings, chances are you had to take out a loan to purchase them. Your lender typically has a security interest in the property (this means that if you don't make your loan payments, it can repossess your car or furniture, or foreclose on your house). This security interest is not affected by bankruptcy in most cases. Since bankruptcy does not erase security interests, the bankruptcy trustee is only concerned with how much equity (value of the property less the balance of the loan) you have in the property.
Each state allows you to exempt a certain amount of equity in your personal property (any property other than real estate) and your house. So whether a trustee will sell your property depends on the amount of equity you have in the property and your state's exemption laws. If you have no equity in your house or personal property, you don't have to worry about the trustee taking them. However, if you wish to keep them, you must continue making regular payments to your lender. Your lender may also require you to "reaffirm" your debt (sign a new contract to make yourself personally liable again) to keep the property after bankruptcy.
Your household goods and clothing usually are fully exempt in your bankruptcy because they typically have little resale value. However, if you do have individual items of high value and are not able to exempt them, then the trustee may try to sell them.
The money you have in qualified retirement accounts (which meet specific requirements to be tax-exempt) are almost always fully exempt. Most retirement plans fit into this category, so you will usually be allowed to keep all of your retirement savings. However, if it is not a valid retirement account or if it is fraudulent, then the trustee can go after that money. Learn about 401k accounts in bankruptcy.
Most states have exemptions that cover a certain amount of your personal property. Some have specific exemptions for items such as jewelry, and may even have a "wild card" exemption that can be used for any type of property. The amount of these exemptions depends on your state.
The Chapter 7 bankruptcy trustee sells nonexempt assets and uses the sales proceeds to repay your unsecured debt—like credit card balances, medical bills, and personal loans—that isn't secured by collateral. Bankruptcy exemptions don't cover specific luxury items, such as fur coats and hobby equipment (known as "nonexempt" property). So if you own an expensive artwork, it's unlikely that you'd find an exemption to cover it.
Even so, you might be able to keep a nonexempt asset if one of the following applies:
Another option? File for Chapter 13 bankruptcy. Debtors can keep all of their property in a Chapter 13 case.
Here are ways you can keep your nonexempt property.
In Chapter 7, the Chapter 7 trustee cannot take any exempt property. However, if you have nonexempt property, the trustee can sell it and use the proceeds to repay your unsecured creditors. Sometimes the trustee decides that it’s not worth seizing and selling your nonexempt property. In that case, the trustee may “abandon” the property.
The trustee will abandon property in several situations. Here are a few.
Secured property is “upside-down” when the value of the loan secured by the property is more than the market value of the property. Car owners are often upside-down on their car loans. For example, a debtor takes out a five-year loan of $25,000 to buy a brand new Toyota, but due to losing her job the debtor must file for bankruptcy two years later. The debtor still owes $20,000 on the Toyota, but the market value is only $15,000. The debtor is now upside-down on the car loan.
In the example above, the trustee will likely abandon the car. Once the secured creditor (loan holder on the vehicle) is paid, there will be no additional funds with which the trustee can pay unsecured creditors. Therefore, it is not worth the trustee’s time or expense to liquidate that car.
If you don’t have a significant amount of nonexempt equity in the property, it might not be worthwhile for the trustee to sell it. From the sale proceeds, the trustee must pay any secured creditor, pay you the amount of your exemption (if any), and deduct the costs of sale and the trustee’s commission. If, after all of these deductions, there is nothing or little left over to pay creditors, the trustee will likely abandon the property.
For example, say you have $5,000 in vehicle equity, and your state allows you to exempt $4,750. Even though there is $250 of nonexempt equity in the car, the trustee is likely to abandon it. Why? After deducting the sales costs and the trustee’s commission from the $250 of nonexempt equity, little or nothing would be left to pay creditors.
After abandonment, the property is released from the bankruptcy estate. If a loan does not encumber the property, then you get to keep it. For example, if the trustee abandons jewelry or household furniture that you own free and clear, you keep the items. If the property is encumbered by a loan (for example, a car that you have financed), you have several options available to you.
Learn more about keeping a car in bankruptcy.
Example. If you own a car worth $5,250 and your state has a $5,000 motor vehicle exemption, the nonexempt portion of the vehicle's value would be $250. The trustee would have to pay you the $5,000 exemption amount before making any distributions to your creditors. Given that it's likely that the cost of storing and selling your car and the resulting trustee fees will exceed $250, nothing would be left for your creditors. In this scenario, the trustee would abandon the car, and you would be able to keep it.
If your nonexempt property is worth too much for the trustee to let you keep it, you can offer to repurchase the asset by paying the nonexempt value. Usually, you can negotiate a lower amount that takes into account the fact that the trustee won't have to incur additional storage and sale costs. You can use the income earned after your bankruptcy filing, or sell exempt property and use the proceeds to fund the purchase. Or, some filers pay for the property with a loan from a friend or family member.
Most debtors in Chapter 7 bankruptcy don't have enough money to buy back a nonexempt asset from the trustee. If you want to keep a specific nonexempt asset, you can offer to give the trustee one of your other exempt assets in exchange. In general, whether the trustee will agree to accept a different asset in exchange for your nonexempt property will depend on the value of the asset and the cost and labor associated with selling each type of property.
It's tempting to engage in a certain amount of exemption planning before filing for bankruptcy, including converting nonexempt property (property you can't protect) into exempt assets you can keep in a bankruptcy case. It's possible to do if it is done in good faith and not with the intent to defraud creditors, but that might not be an easy threshold to meet.
Also, bankruptcy courts have reached inconsistent conclusions regarding how much exemption planning is proper, so it's imperative to discuss your plans with a local bankruptcy attorney. In this article, you'll learn more about converting nonexempt assets into exempt ones.
Exemption planning is the practice of organizing your financial affairs in a way that maximizes your exemptions and allows you to protect the most amount of property in bankruptcy. Converting nonexempt property into exempt assets can be part of exemption planning. However, if you engage in excessive exemption planning, it can be considered bankruptcy fraud and result in criminal prosecution or an objection to your bankruptcy discharge—the order that erases qualifying debt.
It's possible to engage in a reasonable amount of exemption planning before filing for bankruptcy, including converting some of your nonexempt assets into exempt property. For instance, you can use money in the bank (which is often nonexempt) for necessary living expenses such as rent or food. You also have the right to sell your property for the going market rate to pay for necessary expenses. In either case, it's a good idea to keep records of how you spend the funds.
You can also sell nonexempt property to purchase an exempt asset. For example, if you own a boat but don't have a car, it might be in your best interest to sell your boat and purchase a car. First, this would be reasonable because a car is considered an asset that is necessary to get to work, take children to school, and to run household errands. You could also protect the asset in this manner because most states have a motor vehicle exemption but don't offer any protection for boats, which are considered luxury items.
Converting nonexempt assets into exempt property in bad faith or with the intent to hinder or defraud your creditors can rise to the level of bankruptcy fraud. Each bankruptcy jurisdiction has its own opinion regarding the type of exemption planning that is permissible.
When analyzing whether your actions constitute fraud, courts consider:
For example, selling an expensive boat and using the proceeds to pay down a mortgage would likely be considered fraud—but your bankruptcy jurisdiction might view this differently.
Because improperly converting nonexempt property into exempt assets can get you in trouble and could result in denial of your discharge, it's best to err on the side of caution and assume the action would be problematic.
If you are considering filing for bankruptcy and you have nonexempt assets, talk to a knowledgeable bankruptcy attorney in your area to discuss your options and learn about the views of your jurisdiction on exemption planning.