Understanding Bankruptcy Exemptions

Exempt assets
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Most people understand that filing a bankruptcy case will not leave them destitute.They may not, however, understand why that is or how it is that they can keep some property and not other property. It all comes down to what we call "exemptions" or "exempt property." This is property the law specifically allow you to keep after a bankruptcy case. 

Bankruptcy's Overriding Principle: The Fresh Start

An overriding principle in bankruptcy is that of the “fresh start.” The idea is that everyone who files a bankruptcy case deserves to come out of it in a position ready to say goodbye to the difficult times, start anew and get on with life. You can’t do that if you don’t have enough of the basics to carry on with that life. The only way that can happen is if the filer - a person we call a “debtor” - is left with enough property to support him or herself and dependent family members.

When an individual or a married couple files a bankruptcy case, they are not required to turn over all they own to the court and creditors. They are allowed to keep a certain amount of property from the reach of those creditors. The assets a debtor keeps are known as exempt property. The exempt property will include some amount of equity in real property, like the family home, personal property like furniture, clothing, kitchen items, one or more vehicles, tools used in a trade or profession, some amount of current wages, child support and alimony, and other support benefits, and other items.

Only individuals can have exempt property. The assets of a corporation filing Chapter 7 bankruptcy will be liquidated in full. The assets of a corporation filing a Chapter 11 reorganization will generally not be liquidated unless the corporation chooses to do so to fund a reorganization plan. Otherwise, the Chapter 11 debtor will use the future revenue.

What property is protected or exempt in a bankruptcy case?

This is a surprisingly broad question, and it depends on what state you live in, even though bankruptcy is governed by federal law. It can also depend on how long you have lived in that state. Each state has a different scheme and allow their residents to exempt different types of property in varying amounts. For instance, in some states like Texas, under certain circumstances you can exempt all of the equity in your house, even if it's a million dollar mansion. But in other states, like Kentucky, you can only exempt $5,000 in home equity. 

   State-Specific Exemptions

Every state has its own exemption scheme. Many people are familiar with real property exemptions available to homeowners, senior citizens, farmers and others that allow a resident to reduce property tax bills. States also have exemptions used to determine the property a resident can shield from the reach of creditors who would seek those assets to sell and satisfy judgments and other debts.

When the Bankruptcy Code was enacted in 1978, Congress decided to allow each state to choose whether its residents would have to use the state exemption scheme, or whether residents would be allowed to choose between their state’s exemption scheme and one contained in the Bankruptcy Code itself. Currently, only the following states allow residents to choose between the federal or state exemptions. All other states allow only the state exemptions:

  • Alaska
  • Arkansas
  • Connecticut
  • District of Columbia
  • Hawaii
  • Massachusetts
  • Michigan
  • Minnesota
  • New Hampshire
  • New Jersey
  • New Mexico
  • New York
  • Oregon
  • Pennsylvania
  • Rhode Island
  • Texas
  • Vermont
  • Washington
  • Wisconsin

To learn more about a particular state’s exemption scheme, visit this excellent resource: Bankruptcy Exemptions by State.

To learn more about the federal exemption scheme, read Federal Bankruptcy Exemptions.

The 730/180 Day Rule for Applying State Exemptions in Bankruptcy

To use a state’s exemptions, you must also have resided (been domiciled) in that state for 730 days (2 years) before you file the bankruptcy case. If you have not lived in the current state for at least 730 days, you must use the exemptions of the state where you were domiciled the longest during the 180 days prior to that 730/2-year period before filing.

Updated by Carron Nicks, November 2016