An intro to bankruptcy exemptions: what property can you keep when you file?

If you are experiencing severe debt problems, you might be considering bankruptcy. And you’re probably wondering how the bankruptcy process will affect your life. If you file Chapter 7, will you have to give up your car? If you’re filing Chapter 13, how much will you have to pay each month? The answers depend on the bankruptcy exemptions allowed in your state.

Severe debt can cause severe stress, but knowing what you’re dealing with can help you make an educated choice that’s best for you. Here’s an intro to exemptions.

What are bankruptcy exemptions?

Bankruptcy exemptions are property and other assets that can’t be seized by your creditors when you file for bankruptcy.

Bankruptcy’s purpose is to give you a fresh start—not to strip you of everything you own. That’s why state and federal bankruptcy laws include a list of property you can keep. You can keep exempt property out of your bankruptcy by listing it when you file your paperwork.

Every state has a list of property that you can protect, and so does the federal government. Some states allow you to choose their list or the federal government’s list—whichever works out best for you. 

Here are a few typical exemptions:

• A modest vehicle and operating costs

• Some home equity. (Equity is your home’s current market value minus the amount you owe on any outstanding mortgages). This is called the homestead exemption.

• Necessary healthcare expenses like insurance premiums and prescriptions

• Retirement account balances

• Household goods like furniture and electronics

• Tools you need for your profession

• Many states also give a “wildcard” exemption that you can use to protect anything you want. 

All of the exemptions have a dollar limit. The limits vary wildly among states. And we do mean wildly. For example:

• Nevada residents can exempt up to $605,000 in home equity

• Oregon residents can exempt up to $40,000 in home equity

So check the bankruptcy exemptions for your state before deciding whether to file. If you’d have to give up too much, you might want to consider bankruptcy alternatives. 

How do bankruptcy exemptions work?

Bankruptcy exemptions work differently when you file Chapter 7 or Chapter 13. 

Chapter 7 property exemptions

Chapter 7 is pretty simple. The general idea is that you make a list of everything you own and determine if it’s exempt or non-exempt. A court-appointed bankruptcy trustee will sell the non-exempt property and give the money to your creditors. Any remaining unpaid debts are forgiven (it’s called “discharging” the debt).

If you own a car worth $15,000 but your state only allows a $5,000 exemption for a vehicle, it’s partially exempt. The bankruptcy trustee would likely sell the car, return $5,000 to you, and give $10,000 to your creditors. 

Chapter 13 property exemptions

Chapter 13 is more complicated. With Chapter 13, you don’t give up property, but its value is factored in. Too much non-exempt property can make Chapter 13 impossible or very expensive. 

To understand how it works, you need to know that Chapter 13 is a payment plan. You’ll make monthly payments for three years if you’re low income, and for five years if you earn more (those are the only two options). At the end of your plan, any remaining debts are forgiven. 

The amount you pay each month depends on your income, your allowed living expenses, your debts, and your nonexempt property (this is where exemptions play a part).

You don’t have to give up your property, but your creditors will be awarded as much as they would have received if the court had sold your assets. That’s why the payments can be unaffordable.

Using the same example as above, if you file for Chapter 13 and keep your car, you’ll be responsible for paying your creditors the $10,000 they would have gotten if your car were sold. It works this way for all of your nonexempt assets.

How bankruptcy exemptions can help you decide whether to file

Josie wants to file for bankruptcy to get rid of $60,000 in credit card debt. She owns her home and it’s paid off. It’s worth $120,000.

If Josie’s state allows a $40,000 homestead exemption and she files Chapter 7, her creditors would get $60,000 and probably force the sale of her home. 

If she files Chapter 13 so that she can keep her home, her creditors still get $60,000. She’ll be on a payment plan for three years ($1,667 per month) or five years ($1,000 per month). 

Depending on her income, Josie might not be able to afford this payment.

Also, the court won’t approve this payment plan unless Josie has enough money leftover to cover basic necessities like housing, utilities, insurance, transportation, groceries, and taxes. If the court decides that the debt payment is too high, Josie might not be eligible for Chapter 13 at all. She'd be forced to file Chapter 7 and lose her home, or find a way to get rid of the debt without filing for bankruptcy.

This is a simplified example. Bankruptcy is very complex and each person’s details are specific to their situation. The calculations can be tricky. If you’re wondering how exemptions might apply to you, talk to an attorney who specializes in bankruptcy.

Bankruptcy exemption rules you should know

• State vs federal bankruptcy exemptions: If you live in a state that allows you to choose, compare your state exemptions to the federal bankruptcy exemptions list when deciding how to file. (You can’t pick and choose from both lists—you must choose one list or the other.) 

• Residency: If you recently moved to a different state or you’re considering a move to get a more favorable bankruptcy, check your timing. In most cases, you must have lived in your state for two years to qualify for bankruptcy there. 

• Homesteads: Likewise, you can’t pick up and move across state lines for a bigger homestead exemption. Federal law says that you must have purchased your home at least 40 months before you file for bankruptcy to qualify for the state's homestead exemption. If you sold your home in your old state and used the money to buy one in your new state, the time you owned both homes will count.

Deciding how to get rid of your debt

Bankruptcy can be tricky and scary. Talk to professional advisors until you understand how bankruptcy would impact your life. Many bankruptcy attorneys offer free consultations. 

You can also talk to a debt consultant about debt resolution, which is the process of negotiating with your creditors to reduce the amount that you owe. Debt resolution doesn’t require you to give up any of your property. 

Have a few conversations, weigh your options, and then decide. 

Once you start taking control of your debt, you’ll begin to feel better—regardless of how you solve your debt problem.