Homesteads and Bankruptcy Planning: the best laid plans of mice, men and debtors…

While bankruptcy planning is permitted, changes made to the bankruptcy code in 2005 have constrained efforts to convert non-exempt assets into a homestead exemption.  New section 522(o) provides that the value of an interest in a homestead exemption is reduced to the extent the homestead exemption is attributable to non-exempt property that the debtor disposed of in the 10-year period before the case was filed with the intent to hinder, delay or defraud a creditor. 

In other words, if a debtor sells a car that could have been exempted to help with a down payment on a house and then files for bankruptcy and claims a homestead exemption in the amount of the downpayment, the value of the car will not reduce the amount homestead exemption.  But if the car could not have been exempted and the debtor used the proceeds from its sale to buy a home and claimed the homestead exemption to avoid, delay or defraud creditors, the homestead exemption might be reduced in bankruptcy to the extent the value of the car helped create equity in the house.

In In re Stanton, 457 B.R. 80 (Bankr. D. Nev. 2011) the Bankruptcy Court for the District of Nevada analyzed the effect of the addition of 11 USC §522(o).  The court stated Congress added §522(o) “to curb the transmutation of non-exempt assets into exempt homesteads to delay, hinder or defraud creditors.”  It then outlined the four elements a creditor must prove: (a) an increase in the value of the debtor’s homestead; (b) that the increase was “attributable” to the disposition of nonexempt assets; (c) that the disposition of the nonexempt assets was made with the intent to hinder, delay, or defraud a creditor; and (d) that the disposition occurred during the ten-year period ending on the date the debtor’s bankruptcy petition was filed.  Id. at p. 91.  In that case, the court concluded the debtor transferred funds from a nonexempt account to pay a note secured by her residence thereby increasing her equity by some $89,000, with the intent to hinder her sister – a creditor – from collecting on the the debt. The homestead was reduced by this amount.

If you are thinking about filing for bankruptcy but have concerns about what assets you can protect, seek competent bankruptcy advice before you act.