Bankruptcy Exemptions: Why You Need Them

Like an iron gate protecting an entrance, bankruptcy exemptions protect a debtor’s property against loss in bankruptcy.

Theory of Bankruptcy Exemptions

In the old days when a person filed bankruptcy, the story goes, their property was taken and sold or ‘liquidated’, the proceeds then divided among creditors. Any remaining debt was then discharged and the person who filed was given a fresh start on life.

That does not happen under current U.S. bankruptcy law as long as the person filing bankruptcy, also called the debtor, discloses all property and can find enough available exemptions.

Bankruptcy exemptions allow the debtor in a Chapter 7 case to keep exempt property. In a Chapter 13, exemptions help determine how much must be paid to certain creditors.

How Exemptions Work

Assume a Chapter 7 debtor owns a car valued at $9,000. The car loan is $6,000. For bankruptcy purposes, the “equity” value in the car is $3,000. The debtor is in luck because the federal bankruptcy vehicle exemption, as of the time of this writing, is $4,000. This debtor properly discloses the value and the loan then claims a $3,000 exemption. There’s still $1,000 left over for any other vehicle.

Married couples who file jointly can “double” their exemptions, so in the above example they would have a total of $8,000 to use on all vehicles in their names.

Types of Bankruptcy Exemptions

Exemptions must match the type of property on which they are claimed. An important exemption for many filers is the homestead. The homestead exemption protects equity in the debtor’s principal place of residence, but not investment or rental property. Other key exemptions cover clothing, jewelry, tools of the trade and household items such as furniture, appliances and other items.

A “wildcard” exemption can be used to protect pretty much any property and is available in a specific amount but also comes from whatever homestead exemption is unused.

Sources of Exemptions

The U.S. Bankruptcy Code establishes a set of exemptions commonly called the ‘federal exemptions’. However, each state has its own set of exemptions. If you live in a state that has ‘opted out’ of the federal exemptions you may only use the state exemptions. ‘Opt in’ states allow a debtor to choose either the federal bankruptcy exemptions or the state, more accurately called ‘non bankruptcy’ exemptions.

You can’t pick and choose some federal and some state exemptions. Married couples filing jointly must both use the same exemptions. One may not pick state and the other federal.

Retirement Accounts

Exemptions protect most correctly set up retirement accounts. Usually the only limit applies to 401K and IRA accounts, but up to over one-million dollars are exempt. So, it’s never a good idea to draw money out of an exempt account to pay spiraling credit card bills dischargeable in bankruptcy. Retirement accounts protected in bankruptcy are those granted tax free IRS status.

Bankruptcy Exemptions Applied Correctly

That summarizes the basic concept behind bankruptcy exemptions. Think it’s simple? Read U.S. Bankruptcy Code section 522 which spells it all out.

Better yet, in something important as protecting all of your property and giving you a fresh financial start, retain an experienced bankruptcy attorney to help with the legal and procedural intricacies. Bankruptcy requires truthful, complete, accurate disclosure of all property, income, debt and expenses.

My office represents consumer bankruptcy clients in Massachusetts and New Hampshire.

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