In Chapter 7 bankruptcy, there are exemptions to protect some of the equity you have in your assets, like a home, car, or household items. If the exemption for a certain item doesn’t cover all the equity you have in it, you have non-exempt equity. Depending on how much non-exempt you have, the bankruptcy trustee may liquidate (sell) the item and give the proceeds to your creditors.
Written by Curtis Lee, JD.
Updated May 25, 2022
When you file Chapter 7 bankruptcy, you’ll claim exemptions to protect equity you have in your assets, like real estate, a car, or household items. If the exemption amount doesn’t cover all the equity you have in a certain item, you have non-exempt equity. Depending how much non-exempt equity you have in the item, you may need to surrender the item when you file Chapter 7.
Let’s learn more about non-exempt equity by looking at:
The difference between equity and non-exempt equity,
What it takes for non-exempt equity to exist,
How the bankruptcy court treats non-exempt equity, and
What you can do to keep property with a significant amount of non-exempt equity.
Equity vs. Non-Exempt Equity
When you fill out your Chapter 7 bankruptcy forms, you’ll have to list all the property you own and how much, if anything, you owe on it. If you own property that’s worth more than you owe on it, you have equity in that property. For example, if you own a car worth $3,500 and owe $1,000 on it, your equity in the car is $2,500. If you own property free and clear, the equity is equal to its value.
Once you know how much equity you have in each item, you can see if it’s covered by the exemptions available in your state. If you own something that’s not covered or fully covered by an exemption, you have non-exempt equity in that item. Most Chapter 7 cases are “no-asset cases,” which means all the filer’s property — and the equity they have in it — is protected by exemptions. But if you own property that’s not fully protected by exemptions, the trustee can liquidate or sell it to pay back your creditors.
How Exemptions Work
Every state has its own set of bankruptcy exemptions. These determine how much of your property you can keep when you file bankruptcy. There are also federal bankruptcy exemptions. In some states, you can choose between the state and federal exemptions, and in others you must use the state’s exemptions.
Let’s work through an example, so you can see how this works. Say you live in Arizona. Since Arizona requires filers to use state exemptions, you get a $6,000 motor vehicle exemption. That means if you have $6,000 of equity or less in your vehicle, it’s fully protected by the exemption and you can keep the vehicle when you file bankruptcy by claiming the exemption in your forms. If you had more than $6,000 of equity, you’d exceed the amount of the available exemption. This excess amount is non-exempt equity. So only $6,000 of your car would be protected from creditors.
But remember, to calculate your equity, you need to subtract the amount you owe (if any) from the current value of the property. If you owe money on a debt that’s secured with the property you have equity in, the equity is reduced by what you owe.
So ifyou own a car worth $40,000, but have a $38,000 loan on the car (and the car is collateral for the car loan), you would have $2,000 of equity in that car, not $40,000. In most states, including our example state of Arizona, this amount of equity would be fully exempt.
But let’s say you owed $30,000 on a $40,000 car. In this case, you’d have $10,000 in equity in your vehicle. Keeping with the Arizona example, $6,000 of your $10,000 in equity would be protected by the exemption, but you’d also have $4,000 of non-exempt equity.
Secured Debt & Equity
Another reason the value of property doesn’t always tell whether property is exempt or not is because of how bankruptcy treats secured debts. Under the U.S. Bankruptcy Code, a secured creditor has a right to have the property securing their debt returned to them before the debt can be discharged through bankruptcy. The secured creditor’s right to do this exists as long as you still owe the secured creditor money. And whether you have equity in the property makes no difference.
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What Can a Bankruptcy Trustee Do if There’s Non-Exempt Equity?
Typically if you own property that only has a small amount of non-exempt equity, the bankruptcy trustee won’t take that property from you and sell it even if they have the right to do so. This is because little or none of the non-exempt equity would be left after paying the costs of the sale. But if you have a piece of property with a lot of non-exempt equity, the bankruptcy trustee must sell that property. The trustee would take the proceeds from the sale, give you whatever you were entitled to due to your exemption, then send the remainder to your unsecured creditors.
If you’re thinking about filing a Chapter 7 bankruptcy and believe you have assets with significant amounts of non-exempt equity, you may be better off speaking with an attorney about filing Chapter 13 bankruptcy instead.
How To Protect Non-Exempt Equity
Before selling property that has a significant amount of non-exempt equity, most trustees will notify you or your attorney of their intention to do so. This notice allows you to decide what to do.
First, you can choose to allow the property to be sold and have your exemption paid to you from the proceeds of the sale. Second, if you want to keep the property, you can offer to pay the non-exempt equity directly to the trustee and pay your creditors what they’re owed.
If you choose this second option, most trustees will usually accept a good faith offer for less than the total amount of non-exempt equity claimed. They’re willing to accept less than what you technically owe because not having to sell the property themselves saves them money.
A third option is to convert your bankruptcy from a Chapter 7 case to a Chapter 13 case. In a Chapter 13 bankruptcy, the trustee doesn’t sell non-exempt assets. Instead, the filer essentially reimburses their creditors for the value of their non-exempt property through the repayment plan.
Finally, if you don’t think there's non-exempt equity in a piece of property, but the trustee disagrees with you, you can file a motion to abandon the property. In this motion, you show the court proof that the property doesn’t have any non-exempt equity. If the court agrees, the property gets abandoned (or removed) from your bankruptcy estate and is no longer subject to the trustee selling it.
When you decide to file bankruptcy, you should take a moment to determine whether you have non-exempt equity in any of the property you own. Having non-exempt equity may influence whether you decide to file Chapter 7 or Chapter 13 bankruptcy. In Chapter 7, the trustee can sell items with a lot of non-equity for the benefit of your creditors. If you decide to file Chapter 13 instead, you can pay for the item as part of the Chapter 13 repayment plan.