Exemptions define the collection of assets and rights that are safe from the reach of a bankruptcy trustee or your creditors.
But planning exemptions in a bankruptcy case is more than just the looking down the list of things you keep through bankruptcy and the dollar amount that is protected.
Actually, your exemptions in bankrupty swell beyond the stated amount for reasons not printed in the law books.
Add transaction costs to asset value
The unwritten enhancement to exemptions are the transaction costs, those expenses incurred to turn an asset into cash.
A Chapter 7 trustee can sell assets that are not exempt or that have an exemption that covers only some part of its value only if the sale produces money he can distribute to creditors.
To turn some assets into cash, he has to sell them.
There may be an auctioneer or realtor’s commission involved. The sale may trigger taxes.
And the trustee gets paid for his work from a fraction of the money he distributes to creditors. Gotta subtract his commission before paying creditors.
So, add to the exemption value the estimated costs of the trustee’s sale and his commission. Trustees are only supposed to take the debtor’s things for sale if the sale produces a meaningful distributions to creditors.
Why debtors keep their homes
The simplest example of transaction costs at work is a house with more equity than the exemption.
After you’ve taken the sale value of the home and subtracted the liens on the property and the homeowner’s exemption, subtract the realtor’s commission and any other sales expenses to see if there is really equity for creditors available upon a sale.
Take out the trustee’s commission and any capital gains taxes too.
In order to sell an asset, the trustee must show the court that after all the expenses, there will be a meaningful distribution to creditors. If there’s little or nothing left after this calculation, the trustee should not sell the home.
Rearrange your holdings
If you have an asset that can’t be exempted, consider selling it and putting the sale proceeds into an asset that can be exempted.
Sure, you lose the particular asset, but you don’t lose its value, if you can put the money into an exempt form.
There are some limits: you need to get fair market value for the asset you’re selling. No bargain sales to your brother. Arms length transaction for whatever the asset is worth today.
It’s no problem if the asset isn’t worth what it once was, or that the market is depressed.
You just need to realize what the world is paying today for things like it.
Make good use of cash
My favorite use of “extra” cash is to fund an IRA for every bankruptcy filer with available, non exempt money. It is universally regarded as a meritorious move.
IRA’s, after all, now have a federal bankruptcy exemption in excess of $1 million.
Another exemption-expanding stategy is to spend non exempt income and save exempt income. Social Security income is exempt from creditors and from bankruptcy trustees. In California, retirement income is also exempt.
If that’s your situation, consider spending the proceeds from the sale of something that isn’t exempt, and saving the exempt money.
It’s critical that you segregate the exempt income in its own bank account. You want to be able to trace the money on deposit to an exempt source.
More ideas on what to do with non exempt cash.
Get good legal advice
Exemption planning is a tricky subject. Some trustees and some regions of the country take huge offense if a debtor has rearranged things to keep more than he might otherwise have kept.
The larger the sums of money in motion, the more likely you are to hear the dreaded phrase: pigs get fat and hogs get slaughtered.
An experienced bankruptcy attorney can help you find the line between the two.
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