When a bankruptcy case is filed, a bankruptcy estate is created which is comprised of all of the property of the debtor. Exemption laws provide the rules for determining whether that property will be distributed to creditors or whether you’ll be able to keep it. In order to better grasp the concept, picture a warehouse full of all of your stuff. At the front door is a card table with different name tags scattered across it. Each name tag lists a type of property with an associated dollar value. For example, one tag says “car $3,000” another says “house $50,000.”
You are permitted to take the name tags and stick them on all of the stuff you’d like to protect from the trustee. If you run out of name tags and there is still stuff left over, or the dollar value on the tag is insufficient to cover the actual value of your property, it is considered “non-exempt” and could be vulnerable to the trustee. In chapter 7 bankruptcy, trustees can sell non-exempt assets and use the proceeds to pay back creditors. However, in our experience in New Jersey, it is still relatively rare to see any property liquidated. Most people emerge from bankruptcy with all of their stuff.
Exemption laws work to protect property both inside and outside of bankruptcy. In bankruptcy, you are protecting property from the trustee, outside of bankruptcy, you are protecting property from a judgment creditor.
In chapter 7 bankruptcy, exemption laws dictate what property you can keep and what property is subject to sale by the trustee. In chapter 13 bankruptcy, the exemption status of your property will be a factor in determining the size of your monthly payment to unsecured creditors. It is because of bankruptcy exemptions that many consumers are able to eliminate debt in bankruptcy without losing any of their stuff. As I noted above, in most cases, the available exemption laws are sufficient to cover all of your property.
New Jersey Bankruptcy Exemption Laws
Each state has a set of bankruptcy exemptions, as does the federal system created by Congress. In addition, certain non-bankruptcy exemptions protect certain types of property (such as IRAs) no matter which set of exemption laws apply. Although most states require debtors to use their exemptions, some allow debtors to choose between state and federal exemptions. Choosing between exemption regimes can have a big impact on the amount and type of property a debtor can protect. For example, the New Jersey bankruptcy exemptions do not contain a homestead exemption. As a result, many debtors in New Jersey are forced to utilize federal bankruptcy laws in order to shield home equity from the trustee. Keep in mind, that if you recently moved to NJ, the exemption laws of your previous state may apply to your case. However, assuming NJ exemptions apply, let’s run through an example of the federal exemption laws in action.
Example Using NJ Law
The federal homestead exemption allows homeowners to protect up to $22,975 of home equity. Married couples can double. Let’s say John and Jane file a joint bankruptcy petition and list an NJ home, valued at $350,000, in their bankruptcy schedules. The home is encumbered by a mortgage of $325,000, meaning John and Jane have $25,000 in home equity. In this example, John and Jane’s home is exempt, if they file jointly, since they can double the federal homestead exedmption and protect $43,950 of equity.
Sale of Property Doesn’t Defeat an Exemption
What happens if John and Jane had greater non-exempt home equity? Even in the event of a sale, you’ll be receiving a check. Why? Your creditors are only entitled to your non-exempt equity. Remember, your exempt property value is off limits.
Let’s say John and Jane own their home with no mortgage. Were John and Jane’s property sold, they would receive a check for $43,950, which represents the amount of the federal homestead exemption for a married couple filing jointly. Only the non-exempt equity is vulnerable to creditors and a sale does not defeat the exemption.
The Bottom Line
If you’re being pursued by a creditor or are considering bankruptcy, meet with an attorney to learn more about your state’s exemption laws. A good attorney will be able to advise you what property, if any, is vulnerable and how best to protect it. When it comes time to file your case, review Schedule C very carefully and be sure to ask questions if something doesn’t look right. Schedule C of your bankruptcy filing is where your attorney will designate your property as exempt and list the the exemption laws that apply to each type of property.