Kentucky Bankruptcy Law

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Keeping your property through bankruptcy: How exemptions work

When a person files a bankruptcy (referred to as a debtor in bankruptcy parlance), everything they owe and everything they own goes into an estate. In effect, at the moment your attorney pushes that button to electronically file your case, you both as poor and as rich as the day you were born – well, sort of. Unlike a newborn babe, you still have duties under the bankruptcy code and there are some debts that do not go away without a fight (such as some tax debts and student loans). But, for the sake of this missive, we will not concern ourselves with those issues.

Debtors want to keep their stuff. As George Carlin has noted at some length, our stuff is important to us and drafters of the bankruptcy code felt the same way. The avenue to retaining possessions is through the use of exemptions. The overly simplified explanation of exemptions is that you can exchange the exemption that the code provides to you for the property you want to keep. Everyone is afforded certain exemptions. In many state, such as Kentucky, you can elect to use the federal exemptions under 11 U.S.C. Sect. 522(2) or state law exemptions under 11 U.S.C. Sect. 522(3). I touched on this choice briefly in an article about the importance of knowing state law exemptions as well as the federal.

As I noted, though, that view of exemptions is overly simplified. For the vast majority of bankruptcies, that very simple explanation will suffice. However, the truth is that your exemption only covers your “interest” in the property. Interest, in this instance, refers to the monetary value of that property that is exempted. In other words, the estate actually has the property and the trustee, who is under a duty to maximize the return to creditors from the estate, can sell that property. If the property is sold, you would receive the dollar amount of the exemption you claimed and the rest would be distributed to creditors.

What Debtors want is for the trustee to ‘abandon’ the property. This means they are going on record as releasing the property from the estate. If the property is not secured against a debt, then abandoned property comes back to the debtor free and clear. Until the trustee has abandoned the property, then the debtor needs to be careful about selling or otherwise disposing of the property and careful about encumbering the property as collateral for new debt. The trustee almost never does, but can take months or, in some cases, years to abandon property and in rare circumstances you may need to prompt your attorney to file a motion for the trustee to abandon the property if they are taking an unreasonably long time to do so.

Now, there is no need to be concerned if the amount of your exemption covers the fair market value of the property. There is no motivation there for the trustee to take action because they will incur costs in selling the property and they would end up losing money. The only time to be concerned is if the value of the property may be significantly higher than the available exemption. Then, it may be worthwhile to the trustee to attempt a sale of the property.

Another time to be concerned is if your property is likely to increase significantly in value while it is part of the estate. This can happen with real estate (during a normal market) if the trustee keeps the case open for a really long time to administer it. Remember, though, this is very rare. You may have been able to cover the full amount of the equity in your house at the beginning of the case, but the trustee could attempt to realize any increase in equity that goes beyond the exemption limit down the road. Combine increasing value of property with an initial underestimate of its value and you could have something to be concerned about.

From a purely financial standpoint, none of this matters, because you are assured of holding onto the value of your exemption either way. To remember where this whole discussion even matters, we return to George Carlin. Quite frankly, your stuff is probably far more valuable to you than to the free market simply because it is yours. You would rather have that antique chest of drawers your aunt passed down to you than the $750.00 representing your exempt interest in it because of the sentimental value and familiarity of the item.

So, be sure to give a reasonable dollar value for your property to your attorney. Let them have good information so that they can make the best use of the exemptions available. Secondly, be aware that if you have property that currently exceeds exemptions; you may not be able to retain that property. Finally, for any property of significance (e.g. real estate as opposed to the pots and pans in the kitchen) do not dispose of it or encumber it until the trustee abandons it.

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March 18, 2011 - Posted by | Bankruptcy, Exemptions, Planning, Pre-filing planning, Property (exempt, Uncategorized | , , , , , ,

1 Comment »

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    Comment by Peter Harper | August 31, 2011 | Reply


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