Protecting Real Estate in Bankruptcy

"Won't I risk losing my home if I file for bankruptcy protection?"

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One thing many do not understand about bankruptcy is that you normally DO NOT lose your property when you file to eliminate debts. And this is particularly true for the place where you live.

For Minnesota residents, you generally are eligible for a $390,000 homestead exemption (and up to $975,000 for agricultural property). There are certain restrictions, but in general you can apply this exemption to one parcel where you actually reside. And note that the exemption is for your equity in the property. So, if you have a mortgage or mortgages encumbering the parcel, your exemption applies to the net value of your home after deducting the balances still owed on any mortgage debt. So if your Minnesota home has a value of $500,000, but you have a $110,000 mortgage, you can still exempt all of it under the statute. Meaning you can still use bankruptcy to keep the entire value of your home - free and clear - while discharging other, unsecured debts.

Bankruptcy can actually help you save your home

Suppose you missed ten months of mortgage payments - perhaps because you were out of work or experienced some other short-term income loss. You're going to lose your home, right? Wrong. A Chapter 13 reorganization can compel the mortgage lender to cancel any pending foreclosures and accept payments on the past-due mortgage amount over time: up to five years. So if you're $12,000 behind on mortgage payments, you could conceivably schedule a catch-up, repayment plan at $200/month over five years and avoid a foreclosure.

Note that your Chapter 13 would involve other fees - attorney's fees for filing and managing your case plus trustee fees - but you can often spread some of those costs out over the length of the Chapter 13 plan. You can also use the Chapter 13 process to reorganize any other debts you have, potentially saving you big time on other loans and protecting your home equity at the same time. 

"What about the [town home / house / condo] that I'm renting out right now? That's gone, right?"

What if you happen to own "investment property": real estate that you rent but do not use as your residence. Won't you lose that for sure if you file for bankruptcy protection? Not necessarily.

While a bankruptcy trustee will take a hard look at any investment property you own, the trustee is also going to be pragmatic about the costs of getting involved in your investments. First, you might be eligible for a "wild card" exemption to exempt some of the value in your investment - sometimes as much as $10,000 or even slightly more than that (call us if you have questions about how the "wild card" exemption works - it's somewhat complex). That exemption comes off the top and must be paid to you if a trustee elects to sell your investment.

Second, the bankruptcy trustee is going to take into account the costs of sale plus any tax consequences (capital gains on any appreciation). The net value of your property - fair market value minus any mortgage loans, and minus any "wild card" exemption - might be relatively small when the costs of sale are included. In that case, a trustee might not bother trying to sell it at all, meaning you would get to keep it. Or, a trustee might be willing to negotiate with you - giving you the opportunity to keep the investment property if you agree to pay part of its value. The important thing to know is that there are often options and you need to evaluate those before you file.

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Whether you own residential real estate or investment property, do not assume that you will lose it if you file for bankruptcy protection. In many cases the opposite is true.

About the author: Dan Cooke

Image credit:  Timo Newton-Syms