What Are Exemptions? Why Do We Have Them?
For the uninitiated, the concept of asset exemption may not mean much. However, it is an important concept that exists both inside and outside of bankruptcy.
- Exemptions Outside Of Bankruptcy
Outside of bankruptcy, the idea behind exemptions is that if somebody successfully sues you, you shouldn’t end up living under a bridge with just the clothes on your back. Exemptions are meant to protect some of your possessions so that you get to keep them after a judgment has been entered against you. While the creditor can collect against many of your belongings, it cannot take everything and strip you bare.
- Exemptions Inside Of Bankruptcy
In bankruptcy the concept of exemption only applies to individual debtors; it does not apply to business debtors. There are a couple of reasons why we have these exemptions in bankruptcy.
The first reason is really the foundation for the others. In a Chapter 7 bankruptcy, your dischargeable debts just go away without you paying a dime to your creditors. From the creditors’ perspective, that’s a pretty heavy hit. As a result, there are some limitations. One of the limitations is on what you get to keep. While you do get to retain some stuff, there’s at least the potential to lose assets in a Chapter 7. When we prepare a set of Chapter 7 bankruptcy papers for you, we include a complete listing of everything you own or have an interest in; those assets then get divided into two categories: exempt and nonexempt. The exempt stuff will be yours to keep, while the nonexempt stuff will be fair game for the Chapter 7 Trustee appointed to your case to seize and liquidate, and distribute the proceeds to your creditors.
How we determine whether something’s exempt or nonexempt? The Bankruptcy Code is a federal statute with its own exemption table in Section 522, but it also permits states to use their own state tables. California’s unique among the states in that we don’t use the federal table, and we have two state exemption tables: One for homeowners with equity in their principal residence, and the other (our so-called renter’s table) for everybody else. However, homeowners can still use the renter’s table if they wish. Each table has a list of various categories of possessions. Some categories have dollar limits, and others have no dollar limits. Our goal, as we prepare your petition, is to list your assets and stick them into these categories so that they are protected from the depredations of the Chapter 7 Trustee.
The second reason for exemptions in bankruptcy arises in the other two chapters under which most individuals and married couples file for bankruptcy protection: Chapters 11 and 13. (There’s also Chapter 12 for family farmers and commercial fishing operations, which we rarely see in this part of California.) In those chapters, we propose a plan of reorganization that will repay creditors over time. While there is some conceptual overlap between Chapters 11 and 13, there are also fundamental differences that are a little bit beyond the scope of what we’re discussing here.
One of the requirements in both chapters is that the plan must satisfy the Chapter 7 liquidation requirement — unless creditors accept some other treatment. Under this requirement the creditors must get paid at the very least, over the life of the plan, what they would have gotten in a Chapter 7.
Some clients are a bit puzzled when I first state the Chapter 7 liquidation requirement. They reason that if debts just go away in Chapter 7, the creditors get nothing. That is correct for most Chapter 7s. We call those cases no-asset cases. In some Chapter 7s, however, the Chapter 7 Trustee takes any nonexempt assets, liquidates them, and distributes the money to creditors.
Therefore, even though you keep your assets in a Chapter 11 or 13, we still go through the exercise of listing all of your possessions and dividing them into exempt and nonexempt categories because the dollar value of the nonexempt pile is what the creditors would have gotten if you had done a Chapter 7 liquidation. That amount is the minimum that you can get away with repaying the creditors over the life of a plan, so we use it as a factor in determining what the monthly plan payments will be.
The Homestead Exemption
The law changed on January 1, 2021. Prior to that there was a three-tiered exemption structure for exempting the equity in the principal residence of a debtor. The new law changed the exemption of the equity in a person’s principal residence. This exemption cannot be used on other real estate. It can only be used on the principal residence.
The exemption amount is equal to the median sales price in the county where the property is located. The minimum exemption is $300,000 in equity, and the maximum is $600,000. I’m in Los Angeles County, and I serve primarily Los Angeles, Orange, and, to a lesser extent, Riverside Counties. Both Orange County and Los Angeles County have median house prices of over $600,000, so the exemption is $600,000.
There are a couple of caveats here. First, what you’re exempting is not the value of the house, but the value of the portion of the house you actually own — the equity. We start with the market value of the house, and then subtract the amount you still owe; the equity is what’s leftover. That’s what you have to exempt. Unless your house is paid off, the equity is likely going to be under $600,000.
The second caveat takes us to the Bankruptcy Code, which is a federal statute. California has opted out of the exemptions in Section 522 of the Bankruptcy Code, but there is a provision in Section 522(p) that contains an important limitation: If you have not owned the house for at least 1,215 days, then you don’t get your state’s exemption. Instead, you get a maximum of $170,350 exemption of the equity in your house. That’s three 365-day years, plus four 30-day months. If you’ve owned the house for less time than that and you have more than $170,350 in equity, we’ll probably want to postpone filing your bankruptcy papers until you get past that 1,215-day mark. Then, we can exempt the entire equity, unless your equity exceeds $600,000.
This new homestead increase is not a retroactive provision. Therefore, if you filed a bankruptcy case before January 1, 2021, you’re under the old three-tiered scheme, which was much more parsimonious than the very generous exemption structure that we have now. Occasionally, I’ll have somebody pose the question, “I filed in December 2020. Now that the exemption has gone up, do I get to use the higher exemption?” And the answer is no. In fact, there is a Ninth Circuit case law holding that the exemption is fixed on the petition date, meaning the date you file your bankruptcy petition. You don’t get to update the exemption after you file the bankruptcy papers. As a result, the filing needs to be done carefully. Timing, as in so many things in life, is absolutely essential in filing a bankruptcy case.
- Can A Trustee Challenge The Debtor’s Claimed Exemption?
- What Property Exemptions Are Allowed Under the Bankruptcy Code in California?
- Is Your Home Exempt In Bankruptcy in California?
- Does The Homestead Protect Me From Creditors In California?
- How Does Homestead Exemption Work In California?
- Will Someone Be Checking On My Exemptions?
Your Next Step
At the Law Offices of Nicholas Gebelt, we have the resources and knowledge necessary to ensure the best chance of a favorable outcome in a bankruptcy case. To schedule your free 20-minute phone strategy session, call us at (562) 777-9159. During this discussion, we will evaluate your situation, the options available to you, and how best to proceed.
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