In the United States, each state has its own laws governing exemptions from creditor claims for personal property and the primary residence (the homestead exemption). These exemptions allow a debtor to retain a minimal amount of assets when a creditor collects on a money judgment.
Common exemptions include a small value in an automobile (often between $5,000 and $10,000), tools of the trade (similar amounts), unmatured term life insurance (in some states loan value will be exempt and in some, not exempt, or a limited exemption), social security, disability, unemployment and veteran benefits, distributions from retirement plans or annuity contracts (unlimited exemption in some states, and limited to very limited in other states).
For many of our clients, the exemption that is often of greatest interest and value is the homestead exemption. The homestead exemption protects a certain amount of equity in a debtor’s primary residence from being seized by creditors. Note that the homestead exemption may not prevent the forced sale of the primary residence through a judicial foreclosure.
As an example, under the California exemption scheme set forth in the California Code of Civil Procedure, the homestead exemption is at a minimum $300,000, and maximum of $600,000. The numbers are adjusted for inflation and are periodically increased, and currently, the maximum exemption is at $625,000. The exemption you will receive in California is based on the median sale price of a single-family home in your county.
According to realtor.com, the median home price in Shasta County, California is $429,000, which means that is the amount of equity in the primary residence that is exempt under the homestead exemption statute. The same website pegs the median sale price in Los Angeles County at $965,000, which means that $625,000 of equity is exempt.
In practice, a creditor with a money judgment will record the abstract of that judgment with the local county recorder’s office and will then execute a judicial foreclosure. On the foreclosure sale the existing mortgage will get paid off first (it is in first secured position), then the county sheriff will receive their costs of the sale, then the judgment debtor will receive $625,000, and any remaining funds will go to the creditor.
In New York, the homestead exemptions are set forth in the Civil Practice Law and Rules, and vary by county, from $75,000 to $150,000. Under the Illinois Code, the homestead exemption is only $15,000. The Nevada Revised Statutes provide that the Nevada homestead exemption is a generous $550,000. As you can see, exemptions vary greatly by state.
The exemption amount received by the debtor and deposited into a bank account will remain exempt so long as the debtor can trace those funds to the exemption.
Florida, Texas and Kansas do not limit exemptions by value (like almost all states), and instead limit exemptions based on the size of the property. In Florida the homestead exemption will cover up to one-half acre of a home within the city limits, and up to 160 acres outside of a municipality. What happens if you own a one-acre property within the city limits? The creditor will be able to proceed with a forced sale of the property, and the debtor will be able to exempt one-half of the proceeds. In Texas, the exemption covers 10 acres in a city, and 100 acres in a rural area. In Kansas, it is one acre within the city limits, and 160 acres in a rural area.
Like most states, the Florida exemption is set forth in the State’s Constitution, and trumps state statutes, including the voidable conveyance laws. Unlike many other states, Florida has not created statutory overrides for fraudulent transfers. This has allowed debtors, on a last-minute basis, to convert their non-exempt assets (reachable by creditors) into a Florida residence (exempt and not reachable by creditors).
Texas also set forth the exemption in its Constitution, but the Texas Property Code provides that the exemption is lost when the purchase of the property is with the “intent to defraud, delay, or hinder” a creditor, which is the old fraudulent transfer test. This means that moving to Texas and purchasing a residence as a last-minute asset protection move may not work.
In all states, the exemptions are automatic once certain conditions are satisfied, but often need to be claimed to prevent foreclosure sales by filing an appropriate form with the court or the local county recorder. Almost all states require that for the exemption to apply the debtor must be a permanent resident of the state, and physically occupy the residence with the intent of it being their permanent residence.
The exemptions under various state laws are relevant when a creditor is collecting on a money judgment outside of a bankruptcy filing. If a debtor files for bankruptcy protection, then federal bankruptcy laws preempt state laws.
The U.S. Bankruptcy Code allows states to either opt out of the federal bankruptcy exemption or to opt in. If a state opts out, then the bankruptcy debtor will use the exemption available under state law. If a state opts in, then the debtor will use either the state exemption or the federal bankruptcy exemption amount (usually, whichever is higher). Further, if the debtor has lived in her home for less than 40 months (3 years and 4 months) before filing bankruptcy, then the homestead exemption is capped at $189,050.
For example, a bankruptcy filer in Los Angeles County, California, will benefit from the $189,050 bankruptcy law exemption if she has lived in her home for less than 40 months, and will benefit from the California’s $625,000 exemption if she has lived in the home for more than 40 months. This law is intended to stop would-be bankruptcy filers from moving to states like Florida and immediately or soon thereafter filing for bankruptcy and receiving the unlimited exemption.
Recall that the prohibition on the use of the exemption amount of the state the debtor moves to applies only in a bankruptcy. If there is no bankruptcy, the debtor can move to Florida, declare Florida as their new permanent home, and benefit from the unlimited exemption.
The use of the homestead exemption to shield the personal residence of the debtor is far from simple. There are many factors to consider, like the amount of the state’s exemption, the ability to move to a different state, the applicability of fraudulent transfer laws, the need for a bankruptcy filing, and any applicable exceptions to the homestead exemption (like for child support or property taxes).
Even when we are 100% certain that our client will benefit from a generous exemption (say the $625,000 exemption in Los Angeles), what do we do if there is significantly more equity in their home? For example, if our client has $700,000 of equity in their home, we will say just rely on the homestead exemption. You can be 100% certain that you will retain $625,000 out of $700,000. But if our client has $2 million of equity in their home, then the exemption is not sufficient. Do we then suggest that the client move to Florida or Texas? Transfer the home to an irrevocable asset protection trust? Transferring the home to an irrevocable trust sacrifices the entire exemption and the client ends up trading the 100% certainty of exempting the first $625,000 of equity for a lesser certainty of protecting the entire $2 million.
We have helped hundreds of clients protect their homes from creditor claims by navigating this complex area of the law. If you have questions about any topic covered in this article, please email me.
Learn more about author, Jacob Stein here.