What are bankruptcy exemptions?

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Filing for bankruptcy relief does not mean that you have to give up everything you own. The purpose of filing a bankruptcy case is to get debt relief and a fresh start. The result of filing a Chapter 7 bankruptcy would not be a real fresh start if the filer ends up losing all of their belongings. That's where the bankruptcy exemptions come in. 

What Are Bankruptcy Exemptions?

Bankruptcy exemptions are specific laws, either based on state law or the Bankruptcy Code that determine what property your creditors and your bankruptcy Trustee can't touch, no matter what. Property that is exempt can't be sold for the benefit of your unsecured creditors. To protect your property, you have to claim an appropriate bankruptcy exemption when filing bankruptcy. If you don't claim any exemptions, or you claim the wrong exemption, the property is not protected from the Chapter 7 bankruptcy trustee.

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Who Can Claim Bankruptcy Exemptions?

Only individuals can claim exemptions when filing bankruptcy. This includes married couples filing jointly. Business entities can't claim property exempt. Typically, when a business files a bankruptcy case under Chapter 7 of the Bankruptcy Code, the business closes and its property is returned to secured creditors or sold to pay unsecured creditors. Individuals and married couples don't "go out of business" like that, so they're able to protect certain types of property.

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How Does a Debtor Claim Bankruptcy Exemptions?

When filing bankruptcy you will submit a document titled Schedule C to the Bankruptcy Court. This is the document where you (or your bankruptcy lawyer) "claim" your bankruptcy exemptions by listing the state law or Bankruptcy Code provision and specify the exemption amount. Each type of property you own is matched with the law that protects it.

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What is an Exempt Asset?

All personal property and real property fully covered by an available bankruptcy exemption (or federal nonbankruptcy exemption, if appropriate) is considered an exempt asset unsecured creditors and the bankruptcy Trustee can't reach.

If a secured creditor has an interest in the property, you can keep the property as long as your payments to the creditor are current and your equity is less than the available exemption amount. For example, if your home is worth $100,000 and you have a home mortgage of $80,000, your net equity in your home is $20,000. If you live in a state that uses federal bankruptcy exemptions, the entire $20,000 in equity in your home should be protected by the federal homestead exemption.

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Do I Still Owe My Mortgage?

In the above example, the equity in your home would be protected by the federal homestead exemption. Therefore, your home would not be sold by the Chapter 7 Trustee to pay unsecured creditors, like credit cards or medical bills. However, filing bankruptcy and claiming an exemption does not eliminate your mortgage. If you have a mortgage, you have to continue paying the mortgage to keep the real property. If you fall behind on your mortgage payments, the secured creditor can start foreclosure proceedings. The availability of exemptions does not change that. But it does protect your equity, at least up to a certain dollar amount determined by the exemption system you are using.

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Federal Bankruptcy Exemptions vs. State Bankruptcy Exemptions

The Bankruptcy Code is federal law. Therefore, bankruptcy laws apply to cases filed throughout the United States. However, the Bankruptcy Code has a provision that allows states to elect to enact their own bankruptcy exemptions. Therefore, a state can pass laws that require debtors who file in that state to use the state exemptions. Some states have elected to use their own bankruptcy exemptions, but some states allow debtors to choose between federal exemptions and state bankruptcy exemptions.

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Can I Use State Bankruptcy Exemptions?

State law determines whether a filer can use federal bankruptcy exemptions or the state exemptions. Some states allow you to choose between the two exemption systems, others mandate the use of state exemptions.

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What Type of Property Is Protected By Bankruptcy Exemptions?

Most states have similar bankruptcy exemptions. However, the value of the exemptions varies greatly.  For instance, Texas bankruptcy exemptions allow filers to exempt an unlimited amount of equity in their homes if they meet the qualifications for the exemption. However, many states limit the amount of equity a debtor may exempt in a home.

Examples of property that is typically exempt under federal and state bankruptcy exemptions include: • Real property used as a home • Personal Property • Jewelry • Motor Vehicle • Health Aids • Tools of the Trade (property used in a business or employment) • Life Insurance • Public Benefits (including food stamps, Social Security, veteran’s benefits, workers’ compensation, etc.) • Alimony and Child Support Payments • Personal Injury and Crime Victim Awards • Education Savings Accounts • Most Retirement Accounts and Pensions

The above list is not an exhaustive list of bankruptcy exemptions. The federal bankruptcy exemptions and many state bankruptcy exemptions include a wildcard exemption. The wildcard exemption may apply to any type of property the debtor owns. The rules regarding wildcard exemptions vary by state. 

Property that is not covered by an available bankruptcy exemption is considered a non-exempt asset and may be sold by the bankruptcy Trustee in a Chapter 7 bankruptcy case. 

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Do Bankruptcy Exemptions Change?

Yes, bankruptcy exemptions can be adjusted periodically to reflect changes in inflation. Filers must ensure they are using the most current list of bankruptcy exemptions when they file their Chapter 7 bankruptcy case. 

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How Do I Know If I Can Use a Specific State’s Bankruptcy Exemptions?

The Bankruptcy Code has a set of rules that determine which exemption system a filer can use. The rules are designed to prevent a person from moving to a state that has favorable bankruptcy exemptions for the type of property they own just to file a Chapter 7 bankruptcy and move back home. If you have lived in your current state for at least 2 years when you file bankruptcy, you use your state's options for bankruptcy exemptions. If you haven't lived in the state for at least 730 days, you must look back to the 180 days before the 730-day period. The law of the state you lived in the better part of those 180 days before the 730 days determines what exemption system you use. If that state does not allow you to use their exemption system because you no longer live there, you have to use the federal bankruptcy exemptions. 

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How Do Spouses Choose Bankruptcy Exemptions?

When a married couple files a joint bankruptcy petition, each spouse is entitled to claim bankruptcy exemptions for property they own. Therefore, spouses may each claim bankruptcy exemptions for jointly owned property. For example, most states allow a married couple to double the exemption for household goods and similar personal property.

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What Happens to Non-Exempt Property?

In a Chapter 7 bankruptcy case, a Chapter 7 bankruptcy Trustee can take a filers non-exempt property and sell it for the benefit of unsecured creditors. If your property is exempt but the exemption amount is not enough to cover the value of the property, the Trustee has to pay you the dollar amount of the exemption you claimed. The remaining funds are paid to unsecured creditors who claim an interest in your bankruptcy estate. In some cases, a Trustee may allow you to  “purchase” the non-exempt equity in the property. In that case, the dollar amount you have to pay to keep your property is based on the value of the asset minus the exemption amount. So, if your car is worth $8,000 and the exemption is $6,000, you may buy back your non-exempt equity for $2,000. The Trustee may allow you to do this to avoid the cost of conducting a sale of the property.

In a Chapter 13 bankruptcy case, the filer is typically able to keep all non-exempt property by paying a dollar amount equal to its value to the Chapter 13 Trustee as part of their repayment plan.

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Do Debtors Usually Lose Property in a Chapter 7 Bankruptcy Case?

In most of the Chapter 7 cases filed in the United States, the debtors keep all their property. That’s because bankruptcy exemptions protect all the property in most Chapter 7 cases filed, including household goods, musical instruments, tools of the trade, real property used as a home, and retirement accounts. Some property is protected by federal nonbankruptcy exemptions. 

A Chapter 7 case in which the debtor does not lose any property is called a no-asset Chapter 7 case. Most Chapter 7 cases are no-asset cases. But, make sure to carefully review what type of property you own and what bankruptcy exemptions will protect it. 

In some cases a filer may choose to get the much-needed debt relief by filing Chapter 7 bankruptcy even though they may lose certain property. After all, filing bankruptcy and eliminating tens of thousands of debt provides a much greater benefit than keeping a $2,000 piece of real estate that hasn't increased in value in a decade. If you are worried about your state's exemptions or specific types of property and whether they're protected, consider speaking to a bankruptcy attorney.

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