State and Federal Exemptions in a Chapter 7 Bankruptcy
The purpose of bankruptcy is to give you a fresh start. A Chapter 7 bankruptcy wipes out most of your debts by liquidating what you own—the case trustee sells your nonexempt property to pay your unsecured creditors. However, not all of your property is available to the trustee to sell. Much of your personal property and possibly your home are protected by exemptions, which are rights granted to individual debtors by statute that exempt specific categories of property or dollar amounts of specific property from levy, either by creditors or by the bankruptcy trustee. The purpose of exemptions is to give the bankruptcy petitioner at least a minimum amount of property and money to live.
However, when you file for bankruptcy, all of your property becomes property of the bankruptcy estate, including exempt property [§541(a)]. Only property you list in the bankruptcy petition as being exempt will possibly be exempt. If the trustee or a creditor does not successfully challenge it within the allowed time, then it will be exempt. However, if you do not list the property in the bankruptcy petition as being exempt, then it will not be exempt! Hence, it is very important that you list all of your exempt property on Schedule C — Property Claimed as Exempt.
Exempt and Nonexempt Property
Exempt property is property that you are either permitted to keep or to be paid the exemption value if the trustee decides to sell it. However, the trustee will not sell the property unless it is significantly more valuable than the exemption limit. Nonexempt property is property that can be taken and sold by the trustee to pay unsecured creditors. However, the trustee will only sell nonexempt property if the probable sale price is significantly greater than the total of sales cost, liens on the property, and your exemption amount.
There are state exemptions and federal exemptions, but which exemptions are available to you depend on your state of domicile, which is generally where you live when you file for bankruptcy. Even though the bankruptcy code is federal code, the exemptions are determined by state law. You may be able to use federal exemptions, but only if your state allows it.
States that allow either state or federal exemptions:
- New Hampshire
- New Jersey
- New Mexico
- Rhode Island
With states that allow a choice between federal and state exemptions, only 1 set of exemptions can be chosen. You cannot choose state exemptions for some property and federal exemptions for others. However, the choice you do make can be changed by amending Schedule C. California is unique in that it has 2 sets of state exemptions that can be chosen, and, although the federal exemptions cannot be selected, 1 of the California options has most of the same exemptions as the federal exemptions, but with some important differences.
Why State Exemptions Are Used in Federal Bankruptcy
Although the United States Constitution gives the federal government authority over bankruptcies (specifically, Article I, Section 8, paragraph 4: "To establish a uniform rule of naturalization, and uniform laws on the subject of bankruptcies throughout the United States", more info: Bankruptcy Law Sources), there were many who argued that states should have the right to regulate exemptions, since they already provided exemptions for debtors where creditors sought to levy their property through state judicial proceedings, which is why many state exemptions have existed since the 1800's. (This is also the reason why many state exemptions have a very low value, because they have not been updated since the 1800's or early 1900's.)
Proponents of the Bankruptcy Reform Act of 1978 wanted to make the federal exemptions the only exemptions, but proponents of states' rights wanted to keep the state exemptions. A compromise was reached, so the Bankruptcy Reform Act required the use of federal exemptions unless the states decide to opt out, and 35 states did. Just another reason why the bankruptcy laws (and many other laws, for that matter) are far more complicated than they need to be. Indeed, many debtors took advantage of the law's weakness by moving to states that had the highest exemptions.
This ploy was considerably weakened, but not eliminated, by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) that instituted state residency requirements for claiming state exemptions. However, if only federal exemptions were permitted in the 1978 Act without allowing the states to opt out, then debtors wouldn't have been able to take advantage of the system and the new state residency requirements in the BAPCPA would have been unnecessary. So the bankruptcy law using only federal exemptions would not only have made it more fair by giving everyone the same exemptions, but it would have prevented 27 years of abuse and would have simplified bankruptcy considerably by eliminating from consideration the exemptions of each state and eliminating state residency requirements from the code, since it would be moot.
Keeping Nonexempt Property
If property is nonexempt or its value is greater than the exemption limit plus liens and sales cost, you may be able to keep it anyway. If the property has little value or is difficult to sell, the trustee will probably abandon it. If the property has significant value, you can keep it if you pay the trustee the market value of the item or exchange it for an exempt item of equal value. If the value of the property is greater than the exemption value, then you can pay the trustee the difference between the property's market value and the exemption amount.
Types of Exemptions and How They Work
With both state and federal exemptions, there are 3 different types. The most common type is the exemption that has a value limit. Property of a particular type whose market value is below the limit is exempt, while any value above the limit is nonexempt. If the property is not divisible, then the trustee will sell the property, pay you your exemption amount, and use the rest to pay your unsecured creditors. However, if the property was bought with a loan secured by the property, then the trustee will only sell the item if there is significantly more than enough to pay you your exemption and pay the secured creditor; otherwise, there would be little or no money left for your unsecured creditors (or the trustee's commission). For instance, in the state of New York, the exemption for a motor vehicle is only $4,000. So if you own a car bought with a secured loan that has a fair market value of $12,000 and you owe $6,000 on the loan, then the trustee will sell your car, pay you your $4,000 exemption, pay the secured creditor $6,000, and use the remaining $2,000 minus the trustee's fee to pay your unsecured creditors.
Some exemptions apply to specific property, but have unlimited value. Most of these exemptions apply to property that would almost certainly not have much value and would be difficult to sell, such as appliances, specific types of furniture, and Bibles. However, many states also exempt pensions, public benefits, and certain insurance payments without a value limit.
Most types of retirement plans are fully exempt regardless of your state of domicile since they are exempt by federal law. Only IRAs and Roth IRAs have limits that were initially set at $1,000,000 but are adjusted every 3 years for inflation.
Some states and the federal government provide a wildcard exemption, which is an amount that can be applied to any property or divided among several properties where the total does not exceed the limit. However, the amount is usually low. For instance, Ohio has a wildcard exemption of $400 that can be applied to any property. The federal wildcard exemption has a value limit of $975; however, if you don't use the homestead exemption, then you can apply up to $9,250 to protect other property. As with other federal exemptions, these amounts are doubled if filing jointly. The wildcard exemption can also be applied to property that has greater value than provided by the exemption for that property. For example, Florida has only a $1,000 exemption for motor vehicles and a $1,000 (doubled for a joint filing) wildcard amount that can be applied to personal property. So if you have a car that is worth $2,500 and are filing jointly, then you can add $1,500 of your doubled wildcard exemption to the $1,000 exemption for automobiles to protect your car and use the remaining $500 for other personal property.
Doubling Exemptions in a Joint Filing
If both spouses file for bankruptcy jointly, then most states and the federal government allow each spouse to claim the full amount of the exemption; therefore, the exemption amounts are doubled. However, in some states, only specific exemptions can be doubled in a joint filing. As in the example above, Florida's wildcard exemption can be doubled, but not the exemption for motor vehicles. A common exemption that cannot be doubled is the homestead exemption, which is the exemption that you claim on your home. Some states do not allow any doubling of exemptions at all.
Federal Exemption Amounts
Below is a list of some of the federal exemption amounts under §522(d). These amounts are adjusted for inflation every 3 years on April 1 and are valid until the next adjustment in 2016:
- Real property or personal property used as a residence: $22,975
- 1 motor vehicle: $3675
- Household furnishings and goods, clothing, appliances, musical instruments, books, and animals or crops:
- Maximum value for any 1 item: $575
- Maximum aggregate value: $12,250
- Maximum aggregate value of jewelry: $1550
- Maximum aggregate interest in any property: $1225 plus any exemption amount unused for the primary residence, up to $11,500
- Maximum aggregate interest in implements, professional books, or tools used in the trade of the debtor or a dependent of the debtor: $2300
- Maximum aggregate interest in accrued dividends or interest or in the loan value of any unmatured life insurance contract: $12,250
- Maximum payment allowed because of bodily injury, unless the payment is for pain and suffering or for actual pecuniary loss: $22,975