The Bankruptcy "Liquidation Test"

The value of your personal property is always important in bankruptcy. Your property can be protected and exempted from your creditors in bankruptcy, but the exemptions are limited. For instance, if you own a $100,000 house, but owe $90,000 on the mortgage, your $10,000 in equity can be adequately protected from your creditors. However, if you own the same home outright, without a mortgage, your $100,000 in equity is too great to fully protect, depending on the exemptions being used (different exemptions can be used in different circumstances, but that is the subject of another post).

So, what happens when your property is not fully protected? You do NOT have to surrender the property. Instead, you may file a Chapter 13 bankruptcy and submit to the so-called "liquidation test". This test is enumerated in the bankruptcy code under section 1325(a)(4). The liquidation test requires that unsecured creditors (such as credit cards and medical bills) must be paid at least as much in a Chapter 13 bankruptcy plan as they would be paid in a Chapter 7 liquidation, minus any administrative or sales costs.

In practice, this means you must repay your unsecured creditors, dollar-for-dollar, the amount your property would be worth were it to be sold to pay off your creditors, minus whatever is exempted, whatever it is secured by, and whatever costs would be involved in the sale. For instance, if your home is worth $100,000, but you owe $50,000 on the mortgage, and the homestead exemption is $26,000, you must pay your unsecured creditors $24,000, minus estimated sales costs. If you owe your unsecured creditors $24,000 or less, they will be paid in full. If you owe them more, they will be paid a portion of what they are all owed, out of the $24,000 pool.

It should be noted, the exemptions for personal property, such as furniture, clothes, jewelry, tools and household goods, etc. are normally more than sufficient. Also, retirement accounts are usually completely exempt. It is homes, rental properties and cars owned outright that cause the greatest problems with exemptions. It will be important to disclose all property you own to your attorney to guarantee that it all accounted for and protected.

The liquidation test sometimes makes it important to get an appraisal of your home. Appraisals can cost several hundred dollars, but it may be worth it if the results save your thousands (or tens-of-thousands) under the liquidation test. If you only roughly estimate the value of your home, you take the risk of the trustee challenging your case. Precise numbers and amounts will reduce uncertainty.

Contact us if you believe the value of your property could cause a problem with the liquidation test. I will be happy to sit down and review your situation during a free consultation. We can determine if your property will be fully, or partially, exempt. We can plan a Chapter 13 bankruptcy to protect your property if it cannot be protected. We may even determine that your property is not worth liquidating, which will allow you to file a Chapter 7 bankruptcy.