Selling Nonexempt Property Before Filing for Bankruptcy

Selling or transferring nonexempt property before you file for bankruptcy can be a risky proposition. Here's why.

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Selling or transferring nonexempt property before you file for bankruptcy can be a risky proposition.  Depending on the circumstances, a bankruptcy trustee may be permitted to recover the transferred property as part of your bankruptcy estate, exemptions which would allow you to keep certain property could be limited or denied, or you could even be denied a discharge of your debts.

Whether a prebankruptcy transfer or sale of property lands you in hot water depends on the following factors (discussed in detail below): 

  • whether the property was exempt or nonexempt
  • when the transfer was made
  • whether you received fair value for the property
  • how you spent the proceeds, and
  • why you made the transfer.

The Type of Property Sold or Transferred: Exempt vs. Nonexempt

Generally, the sale or transfer of exempt property is fine. Selling or transferring nonexempt property, however, can get you into trouble. 

What is Exempt Property?

Exempt property cannot be taken by creditors to satisfy a judgment against you. When you file for bankruptcy, you are allowed to keep this property. What property is exempt varies by state and federal law. Some examples of property which are often exempt include your primary residence, limited equity in a motor vehicle, household goods up to a certain value, cash value of life insurance policies, annuities, and retirement accounts.

Nonexempt property is all property that is not subject to an exemption by law. In Chapter 7 bankruptcy, the bankruptcy trustee can sell nonexempt property and use the proceeds to pay your unsecured creditors. 

To learn more about exempt property, including what exemption laws apply in your case, see our Bankruptcy Exemptions area.

Selling Exempt vs. Nonexempt Property Prior Bankruptcy

Selling exempt property before you file for bankruptcy is not a problem as long as you receive fair value for it. This is because the trustee could not have liquidated this property anyway.

But there's little reason to sell exempt property prior to bankruptcy if what you really want is to keep it -- because exempt property is safe in Chapter 7 bankruptcy.

On the other hand, it would be ideal if you could sell all of your nonexempt property and use the proceeds to buy more exempt property or pay down liens or mortgages on exempt property. This, however, is where it gets risky.

Prebankruptcy Planning Is Discouraged

Selling nonexempt property to maximize or enhance your exemptions when you know or suspect that you will file for bankruptcy is generally referred to as "prebankruptcy planning." The bankruptcy laws discourage prebankruptcy planning, especially when it is done with the intent to hinder, delay or defraud creditors.  

How Far Back Will the Bankruptcy Court Look?

The court can look back in time and investigate a prebankruptcy transfer or sale of property. The time period the court can look back varies depending on the type of property involved and the reason the transfer is being investigated. In certain types of transfers that increase the value of your property for which you claim a homestead exemption, the court can look back as far as ten years. 

Did You Receive Fair Value for the Property?

Whether you received fair value for the property may play a role in determining whether the transfer was done to hinder, delay or defraud creditors. If you did not receive fair value for property transferred, the bankruptcy trustee may file a lawsuit to recover the transferred property. Under bankruptcy law, the trustee can review transfers made within two years prior to the bankruptcy filing; possibly farther back under state laws.

Once the trustee recovers the property, the person who received the transfer could make a claim in your bankruptcy case to try to get the money back. If the property was property that you could have claimed as exempt, you will lose your right to claim the exemption. 

What Did You Buy With the Proceeds?

If you purchased new exempt property, increased the value of the existing exempt property, favored a particular creditor over others, or purchased luxury services, such as an expensive vacation, it is likely the transfer will come under scrutiny. Here's what could happen in your case:

If you preferred one creditor over others by paying down the debt owed to that one creditor with the proceeds or property, the trustee can file a lawsuit against the creditor to recover the payment or the property so that the proceeds can be used to pay all creditors equally.  This applies to payments made to general creditors within 90 days prior to the bankruptcy filing and "insider" creditors, such as family, within a year prior to the bankruptcy filing.

If you purchased new exempt property or increased the value of your exemptions, the court could disallow the exemption, limit the amount of the exemption allowed or deny your discharge entirely, depending on what your intent was behind the transfer.

How Does the Bankruptcy Court Determine Your Intent?

The court will attempt to infer your intent from the circumstances surrounding the transfer and will also consider your testimony. Every case is different and you can’t rely too heavily on what was allowed in the past to determine whether a particular transfer you make will be allowable.

Courts often look for "badges of fraud" to determine your intent, which may include a review of:

  • whether you received fair value for the property
  • whether you retained control over the property
  • your financial condition at the time of or just after the transfer
  • whether the transfer was to a family member or other person close to you
  • whether the transfer was in response to someone's threat to sue you
  • whether you concealed the transfer, and
  • what you had left after the transfer.

Special Rules When You Use Sale Proceeds from Nonexempt Property to Increases the Value of Your Homestead

If you use your state's exemptions and you sell non-exempt property within 1215 days prior to your bankruptcy filing and use the proceeds to increase the value of your homestead residence (by paying down the mortgage, making improvements, or buying a more expensive house), the court can reduce your homestead exemption by the amount of the enhancement to the extent that the value exceeds $146,450. Under these circumstances, the court does not have to consider your intent behind the sale.

Simply repairing or maintaining your residence, or using sale proceeds to make your regular mortgage payment should not trigger the reduction. This also does not apply to proceeds transferred from a prior residence into a new residence in the same state or at all if you qualify as a family farmer.

To learn more about prebankruptcy planning, and actions to avoid prior to bankruptcy, see Filing Considerations & Prebankruptcy Planning.

by: , Attorney

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