What kind of property may I retain as “exempt”?

As noted in the Chapter 7 overview, a trustee is assigned whose job it is to “liquidate” a debtor’s property and then distributing the proceeds to creditors. In reality, only a very small percentage of cases ever result in liquidation of assets. In the vast majority of cases, the trustee quickly determines that it is a no-asset case (meaning there are no assets for the benefit of creditors). Even in a “no-asset” case, a debtor may have substantial actual assets. This is because their assets are often entirely “exempt.”

Once a person files a Chapter 7, with a few exceptions, the property they own is considered part of their "bankruptcy estate." Property of the estate is defined in the Bankruptcy Code at 11 U.S.C. § 541. Such property definition is quite broad and often consists of esoteric rights that are not apparent at first glance. Beyond the obvious bank accounts, personal possessions and real property, such property rights may include the right to sue someone, a tax refund due and community property rights among other things. Congress, considering the death of someone a fortunate windfall to be shared with creditors, has designed the statute so that the right to inherit or get life insurance from someone who dies within 180 days of the filing of the bankruptcy to be property of the estate as well!

While the estate includes just about everything under the sun, a person who files bankruptcy is able to claim certain of their property as exempt.

Exempt means that the property is off limits to creditors and not subject to administration in the bankruptcy case. Like other areas of bankruptcy law, the exemption scheme can be quite complex and a lawyer should always be consulted. Every state has a different exemption scheme and what exemptions apply require knowledge of both federal and state law. Because of changes incorporated by the Bankruptcy Reform Act, a person may even be required to claim exemptions from the state of previous residence.

In California, a debtor is able to claim exemptions from either of two different systems. These systems are generally found under the California Code of Civil Procedure in CCP § 703.140, or under CCP §§ 704.010 – 704.210, and CCP §§ 704.710 – 704.730.

THE CALIFORNIA EXEMPTION STATUTES WERE LAST REVISED ON APRIL 1, 2007 (next revisions due on April 1, 2010). THE ATTACHED DOCUMENT, PUBLISHED BY THE CALIFORNIA JUDICIAL COUNCIL, MUST BE CONSULTED FOR UPDATED EXEMPTION AMOUNTS.

There are other federal and state exemptions that supplement these as well. A nice summary of the California exemptions can be found here.

The choice of systems depends on which is more favorable to the client and a host of complex factors may come into play. A homeowner with substantial equity is more likely to pick the 704 system. A homeowner with little or no equity and $10,000 cash in the bank may very likely pick 703. The big advantage of the 703 system is that it has a “wildcard” which can be applied into any property. The total value of the California wildcard is presently $21,825. So, for property which exceeds the basic exemptions already provided for personal property, an automobile, bank accounts, jewelry and the like, the wildcard permits property of otherwise excess value to be exempted. Exemptions basically serve to protect the debtor from being rendered a pauper and provide them a “grubstake” for their fresh start. Many California residents are surprised to learn that, because of the wildcard, they are able to file bankruptcy and exempt substantial amounts of cash and equivalents. Debtors in some other states are not so lucky.

I have prepared two different examples to demonstrate how exemptions at work. Property in a bankruptcy case is listed on Schedules A & B. Exemptions are claimed on Schedule C. Just click on the link to view a PDF file.

EXAMPLE #1:

This debtor owns a BMW worth $13,000, with a car loan lien of $6,860.51. The net equity in the car is $6,139.49. Notable property also includes a Bank of America checking account of $3,870, a diamond/platinum ring worth $7,000, a tax refund due of $3,911, and $52,000 in a 401k plan. There is a mish-mash of other property as well.

ALL OF DEBTOR’S PROPERTY IN EXAMPLE #1 IS EXEMPT AND THIS WOULD BE DETERMINED TO BE A “NO-ASSET” CASE!

Of the equity in the car, $2,975 is exempt (revised to $3,300 on 4/1/2007) by way of the 703 vehicle exemption; the remaining $3,164.49 of exemption comes out of the wildcard pot. The 703 jewelry exemption of $1,225 (revised to $1,350 on 4/1/2007) ) is claimed for the diamond/platinum ring; the remaining $5,775 in value comes out of the wildcard pot. The tax refund due to debtor of $3,911 comes entirely out of the wildcard pot. Retirement funds like a 401k are exempt under the 703 system in their entirety. However, retirement funds are generally exempt (and may not even be property of the estate) under a variety of other statutes as well. In fact, retirement funds are one of the few true consumer protections incorporated by the Bankruptcy Reform Act; such funds should now be virtually off-limits in all states by way of new 11 U.S.C. § 522(b)(3)(C).

In Example 1, all of the debtor’s property was exempt but she used up virtually all of her available wildcard. If she had cash and equivalents that exceeded the amount of exemptions that she could claim, she might have wanted to put off her bankruptcy filing until her property was below the exemptible threshold so that a trustee would not gobble up the asset for distribution to creditors.

EXAMPLE #2:

This debtor also owns a BMW, this one worth $15,000 with no liens. This debtor has a condo worth $600,000 and a mortgage of $500,000. He has $10,000 in the bank, all traceable to paid earnings within the last 30 days.

This debtor has chosen the 704 system because of the ability to claim more exemption for homeowner equity. Because this debtor is single, has no other qualified family members, is neither disabled nor elderly, he is able to exempt only $50,000 under the 704 system (under different scenarios, a debtor could claim an exemption up to $150,000 in California). Also, under the 704 system (which has no wildcard), he is only able to exempt $2,300 (revised to $2,550 on 4/1/2007) of the BMW’s value, leaving $12,700 as not exempt. The good news is that, under the 704 system, this debtor is able to exempt $7,500 of the $10,000 in paid earnings in the checking account (leaving only $2,500 as non-exempt).

This would be an asset case. Here, at the very least, the trustee would demand turnover of $2,500 from debtor’s checking account. Plus, the trustee would sell the BMW. From that the sale of the car, a trustee would have to give the debtor $2,300 (now $2,550). The house is another matter. The fair market value is $600,000. With a $500,000 mortgage, and the debtor’s $50,000 exemption, there is hypothetical equity of $50,000. However, the costs of sale (including broker’s fees and commissions) may very well consume that entire $50,000! In that case, the condo would yield nothing for creditors and might not be administered in the bankruptcy case by the trustee.

Had the scenario been less equity in the home, the choice might have been the 703 system, possibly permitting the entirety of the car and the bank account to be exempted. Bankruptcy law can be complex. Choices of exemptions require careful and thoughtful analysis by a trained attorney.