For those who are considering filing a Chapter 7 bankruptcy, a common misconception is that the bankruptcy trustee will seize or take away all of a debtor's existing property. This is untrue.
Debtors are entitled to certain exemptions when a bankruptcy is filed. An exemption allows a debtor to keep property up to a certain amount, and in some instances the exemption is unlimited, such as with retirement funds held within a qualified account such as a 401(k) or IRA.
Debtors may keep exempt assets. Any assets that are not fully exempt may be turned over to the bankruptcy trustee to liquidate and distribute to creditors. The exemptions are applied to the equity of an asset. Equity refers to the market value of a certain asset after all liens against it have been paid. Because a debtor is entitled to a fixed amount of certain exemptions, it is important to value your assets accurately.
For example, in California, debtors filing bankruptcy are entitled to a motor vehicle exemption in the amount of up to $3,525.00 depending on the system of exemptions chosen by the debtor. If a debtor has a car with a market value of $5,000.00 and no debt against it, the latter vehicle exemption will cover $3,525 of the equity in the car. Obviously, the vehicle exemptions does not fully cover the market value of the car. Fortunately, California will also allow the debtor to use a wildcard exemption to make up for the difference in equity in the car. Currently, the combined "wildcard" exemption in California is $23,250.00 (under the CCP 703 exemptions). The wildcard may be used for a debtor's miscellaneous property not covered by an existing exemption or to make up for an exemption that may not fully cover the market value of property, such as in this example. Because the motor vehicle and wildcard exemptions fully cover the market value of the car, the debtor will be allowed to keep the car even though a bankruptcy is filed.
Certain exemptions are unlimited. This means that a debtor may keep certain assets regardless of the value of that asset. Most notably are valid retirement accounts. If a debtor has accumulated retirement funds within a 401(k), for example, the entirety of that 401(k) is exempt and the debtor may keep it. Please note that funds kept in a regular savings account that have been designated by the debtor as retirement money does not qualify for this exemption. The funds must be placed in a legitimate qualified retirement vehicle to be exempt form creditor access.
For assets that are only partially covered by a debtor's allowable exemptions (i.e., the equity exceeds the amount of the exemption(s) used), the bankruptcy trustee may seize the entire asset and sell it. The trustee will return, and the debtor will be allowed to keep, the amount of equity covered by the exemption. The remaining proceeds of the sale will be distributed to the debtor's creditors.
There are a number of other assets that qualify for an unlimited or nearly unlimited exemption amount, such as IRA savings depending on when contributions were made. The analysis of a debtor's assets, their values, and the available exemptions in Chapter 7 are critically important and among the reasons it is imperative to consult with an experienced bankruptcy attorney.
For more information on specific Chapter 7 exemptions applicable to California residents in bankruptcy, please visit our article "What Are Bankruptcy Exemptions?" at our San Jose Bankruptcy Attorney website.
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