Chapter 7 bankruptcy is becoming a popular option in today’s strained economy. However, one of the first concerns of those considering such a step concerns what property can they retain. That is because Chapter 7 bankruptcy is a liquidation process by which a trustee takes charge of the bankruptcy estate and may liquidate those assets that are not protected under exemption laws.
Once all those assets are considered, the remainder of most consumer debt is discharged, or erased, allowing the debtor to start fresh. However, the list of protected or exempt property is limited, although it varies according to state laws and whether or not a state allows filers to use federal exemption standards.
Federal and State Exemption Laws
Federal exemption laws are standard throughout the U.S., however, not all states allow their citizens to use federal standards. Every state has their own exemption statutes, and in most cases, states require those statutes to take precedence over federal standards. A few states allow debtors to choose either state or federal exemption statutes.
Federal laws have no specific exemption for investment rental property; although there is a homestead exemption that may apply if the filer can claim that property as their primary residence and they are renting out a portion of it. In addition, there is a wild card exemption that the filer may apply to any property they choose, as well as $10, 125 in unused homestead exemption that the consumer may apply to other property, as well.
State laws vary, but generally, investment rental property is not exempt and the filer can only protect it as a wildcard claim.
Bankruptcy Trustees
In cases where a debtor has investment rental property in which they have no equity, they often would not wish to retain that property after filing Chapter 7 bankruptcy, especially if there is a mortgage on it. However, many trustees are not interested in administering such property during a bankruptcy proceeding. They are unwilling to incur the cost of marketing, maintaining the upkeep, and processing the sale of this kind of property in today’s market.
In addition, they may be unwilling to hold liability for that property during the process of liquidating it. As a result, they often abandon that property and allow the debtor to keep it if they so desire.
However, if the property is occupied and there is income from that property, the trustee may claim that income between the date of the bankruptcy filing and the date they abandon that investment rental property. At that point, the property and the income revert back to the debtor.
The "Cram Down" Option
If a debtor instead chooses to file under chapter 13 bankruptcy, there is an option to "cram down" or "strip" the principle on a rental mortgage that exceeds the value of the property. This is a powerful tool for people who have become underwater do to decreasing real estate values, and can eliminate the principle that makes the mortgage payments difficult and limits refinancing options.
Always Talk to a Lawyer First
While there are many trustees who do not want to incur the cost of liquidating investment rental property during a bankruptcy settlement, there is no guarantee that that will be the case. However, a local bankruptcy attorney will be familiar with the practices of the regional bankruptcy trustee and may be able to provide insight about these options. In addition, they may be able to help the debtor find the best exemption options and bankruptcy preparations to provide the greatest benefit to their client during this difficult process.
