This article is written by Daniel Weintraub & James Selth of Weintraub & Selth APC a Los Angeles Bankruptcty Law Firm.
This article is part 2 of the series "What Happens to My Home If I file for Bankruptcy" Read Part 1 Here
So how does one apply the homestead exemption? Like all exemptions, the homestead exemption only protects EQUITY in the house. One computes equity for purposes of determining the homestead exemption by taking the fair market value (FMV), deducting costs of sale (estimated between 6 and 8%) of the FMV and deducting any unpaid real estate taxes and all liens (typically your mortgages including any HELOC and other liens including judgment and tax liens).2 [FN2 While the trustee must consider all liens in determining whether there is equity available to the bankruptcy estate, it is important to note that the homestead amount takes priority over (comes before) judgment liens, state tax liens and other involuntary liens which can be "avoided" by a person filing for bankruptcy protection]. If the remaining amount is equal to or lower than the applicable exemption amount, the trustee cannot sell your home in bankruptcy.
So what happens if the equity amount is greater than the applicable homestead exemption? Practically speaking, while no guarantees can be given, it is unlikely that the trustee will sell the home unless the remaining equity is $20,000 or greater. But if the equity is significantly greater than the exemption amount, the trustee may sell the home. if the trustee does so, the funds from the sale are distributed in this order
|1||Closing Costs||Broker/Equity/Title||Estimated at 6-8% of FMV|
|2||Real Estate Tax||County Tax Collector||Full Amount Due|
|3||Voluntary Liens||Typically banks but may also include private parties with a deed of trust on the property||Full amount(s) due|
|4||Homestead for relief||Person(s) Filing Bankruptcy||Amount allowed by CCP 704.730|
|5||Involuntary Liens||Typically judgment liens, tax liens or HOA liens||Full amount(s) due|
|6||Bankruptcy estate||Bankruptcy Trustee||Any remaining amount|
The trustee will generally only sell the home if the equity is sufficient to cover items 1-5, which in our experience is rare.
In the event of a forced sale, the exempt cash is protected from creditors for a period of six (6) months after the proceeds are received by the party claiming the exemption unless invested in a new homestead. What this means is that creditors and even the trustee may go after the funds if they have not been spent or reinvested within that six (6) month period. As mentioned above, the law under consideration, which we believe has a strong possibility of becoming the new law in California, would provide that such exempt funds are permanently protected.
Persons with equity which is not protected by the homestead exemption should consider filing a Chapter 11 or 13 case. In these chapters, there is no trustee with control over assets and whether or not they are sold. Instead, the person filing makes these decisions. Generally speaking, a Chapter 11 or 13 case allows persons filing for bankruptcy relief to keep their assets provided such person(s) pays creditors over time under a plan of reorganization at least as much as they would have received if the assets had been liquidated in Chapter 7 bankruptcy. Chapter 11 and 13 cases (especially Chapter 11) are more complicated and require the steady hand of an experienced bankruptcy lawyer.
Much like serious medical problems, financial problems are best addressed through early intervention and "treatment". Early detection and active engagement allows your attorney to more effectively plan your case and increases the odds that your bankruptcy filing will not only achieve your goals, but also maintain your assets and be less disruptive for you.