Can I Keep a Second Home in Chapter 7 Bankruptcy?

In most cases, if you have equity in a second home, vacation home, or house you use as an investment, you won't be able to keep it if you file for Chapter 7 bankruptcy. There is nothing within the bankruptcy laws that strictly forbids you from keeping a second home in your Chapter 7 bankruptcy. But because states do not have specific exemptions (laws that allow you to keep certain property in Chapter 7) to protect a home that is not your residence or your dependents' residence, most people have to turn the home over to the bankruptcy trustee.

In essence, whether you can keep your second or vacation home in Chapter 7 bankruptcy depends on how much equity you have in the house, what bankruptcy exemptions are available to you, and whether your dependents use the house as a residence.

How Do Exemptions Protect Your Property in Bankruptcy?

When you file a Chapter 7 bankruptcy, the bankruptcy trustee may sell the property that you own to pay your creditors in full or in part. Because the bankruptcy laws are created around the idea of a fresh start, though, you are not expected to give up everything you own. You can protect much of your property through the use of exemptions.

Exemptions vary by state, but generally allow you to keep a certain amount of equity in property like your residence, automobiles, and household goods. Exemptions can vary widely in the amount of equity they allow you to protect. Some states, for example, allow you to protect several hundred thousand dollars of equity in your home, while other states limit you to ten or twenty thousand dollars. (Learn more about bankruptcy exemptions and find the exemptions available in your state.)

If the trustee sells your property, he or she must pay you the exemption amount out of the sale proceeds. The trustee will also take his or her commission from the sale proceeds, pay off any liens or loans that are secured by the property, and then distribute the rest to your creditors. This means that if all of your equity in an item of property is protected by an exemption (or by several exemptions combined), the trustee won't have any interest in selling it and you get to keep it.

Example 1. Say you own a car worth $5,000, you don't have a car loan, and your state has an automobile exemption in the amount of $5,000. If the trustee were to sell your car and pay you the $5,000 exemption amount, there would be nothing left for your creditors. In this situation, you'd get to keep your car.

Example 2. Suppose in the above example you still live in a state that allows a $5,000 exemption in an automobile, but that your car is worth $12,000. In this scenario the bankruptcy trustee would sell your car, pay you $5,000, use the remaining $7,000 to pay for the costs associated with the sale and the trustee's commission, and then distribute the remainder to your creditors.

How Much Equity Do You Have in the Second Home?

The trustee will determine whether or not you have sufficient equity in your second home to make it worthwhile to sell it for the benefit of your creditors. This requires answering two questions:

• How much is the home worth?
• How much equity do you have in the home?

Valuing Your Second Home

With real estate and all other property, you must report to the trustee what you think your property is worth. Recent appraisals, comparative sales analyses, or the opinion of a local real estate agent may help you to value your second home. Although it is often not as reliable as these other sources, you may also look to the tax appraisal issued by the appraiser's office where your home is located. Be prepared to explain to the trustee how you arrived at the value you report, and know that the trustee may want to independently determine the estimated value of the property. (Learn more about how to value your home in bankruptcy.)

Figuring Out How Much Equity You Have In Your Vacation Home

In order to calculate the equity you have in your second home, you start with the home's value and then subtract the balance of loans or liens that are secured by the property. This includes mortgages, home equity loans or lines of credit, tax liens, and judgment liens – the trustee will have to pay these off before distributing funds to your creditors.

Example. Your home is worth $250,000. You have a mortgage on the home with a balance of $100,000. Your equity in the home is $150,000.

If the trustee determines that there is equity in your second home, he or she will consider whether it makes sense to sell the property. In order to make it worth the effort, there must be sufficient funds to pay creditors after:

• deducting the costs associated with selling the property
• taking his or her commission
• paying you your exemption, and
• paying off any liens against the property.

If, after all of these things are paid, the trustee predicts that there would be significant funds to distribute to the creditors, the trustee will likely sell your vacation home.

Which Exemptions Can I Use on a Second Home?

The homestead exemption is often very generous, but unfortunately you can only use it to protect real property that you use as a residence for yourself or your dependents. You cannot apply the homestead exemption to homes that are used as rental property, vacation homes, or simply kept as family or investment property.

The Wildcard Exemption

In most states, the only exemption available for second homes is the ‘wildcard' exemption; not all states have a wildcard exemption, however. In most states the wildcard exemption is less than a couple thousand dollars per individual. In some states you can use it to protect any type of property (and therefore can combine it with other exemptions); in others you can only use it to protect property not covered by other exemptions. Because the wildcard exemption is usually small, it offers little protection for second homes.

The Homestead Exemption for Homes Where Your Dependents Live

If you happen to own a second home that is used as the residence of your dependents, you may be able to use the homestead exemption as long as you do not also need that exemption to protect your own residence. This situation sometimes comes up when you own a second home that your ex-spouse and children live in. Assuming these children are still your dependents, you may be able to use the homestead exemption to protect this home.