At the beginning of this year (2021) the amount of home equity a California homeowner can protect from his or her creditors greatly increased. See our blog post, Huge Increase in California Homestead Exemption, about this. This new greater protection of home equity makes understanding the federal Bankruptcy Code’s limitations on homestead exemptions all the more important and timely.
HOW CAN FEDERAL LAW LIMIT CALIFORNIA HOMEOWNERS’ RIGHTS TO THEIR HOME EQUITY?
Bankruptcy is a federal procedure, as provided under the U.S. Constitution. See Article 1, Section 8, Paragraph 4. Under the Supremacy Clause, Article VI, Paragraph 2 of the Constitution, the federal constitution and federal laws are above state constitutions and laws. States can’t interfere with federal exercise of its constitutional powers.
So, states can create homestead exemptions, protecting their homeowners’ home equity from their creditors. And Congress can make laws allowing the use of those state homestead exemptions in bankruptcy cases. It has done so. But Congress can also limit the use of those homestead exemptions. It has done this as well. Those federal statutory limitations on the California homestead exemptions in bankruptcy court are the subject of this blog post.
WHAT ARE THOSE FEDERAL STATUTORY LIMITS TO THE CALIFORNIA HOMESTEAD EXEMPTION?
There are three important ones:
- Homes purchased within about 40 months before filing bankruptcy
- Debtors convicted of a bankruptcy felony or owing other bad-act debts
- Home equity acquired from non-exempt assets disposed of within the prior 10 years by the homeowner with the intent to hide the assets from a creditor
We’ll cover these now one at a time.
WHY LOSE A HOMESTEAD EXEMPTION FOR THESE REASONS?
This is not about losing your right to a homestead exemption altogether, but rather about limiting it to a certain maximum amount.
If the conditions for the first two of the limit would apply, your homestead exemption would be limited to $170,350. (By law this amount is adjusted every three years for inflation; this current amount is valid through March 31, 2022.)
This cap at $170,350 is substantially less than the new California homestead exemption amounts effective since the beginning of this year. Those new exempt amounts are between $300,000 and $600,000, depending on the home values in your county. (Again, see our earlier blog post for the details.) So when that $170,350 homestead exemption limit applies, that’s would protect a lot less of your home equity from your creditors.
However, also be aware that, if the equity in your home is no more than this $170,350 amount, being limited to that amount would likely have no practical effect. Being able to exempt more home equity would not matter if you don’t have any more equity that you needed to protect.
WHY LIMIT A HOMESTEAD EXEMPTION ON A RECENTLY PURCHASED HOME?
The reason for limiting a newer homeowner’s homestead exemption is to limit the ability of high-asset out-of-state debtors to shield substantial money from their creditors by using those assets to buy a home in a new state with a high homestead exemption. With California’s now-much-larger homestead exemption amounts, this reason applies all the more to people moving their otherwise-exposed assets into high-equity homes in our state.
UNDER WHAT CONDITIONS DOES THIS LIMIT APPLY?
This limit to $170,350 only applies under the following timing, location, and occupational circumstances. If:
- you bought your California homestead within 1,215 days (three years plus 120 days) before filing bankruptcy;
- even if this timing condition is met, the equity from that purchased homestead did not come from the sale of another principal residence in California, which itself was purchased before the 1,215 day-period; or
- The current California homestead is not the principal residence of a family farmer.
So this $170,350 limitation does not apply if you bought your home more than 40 months before filing bankruptcy. And even if you did buy it within that time, the limitation does not apply if your present equity originated from the sale of another California principal residence, which you had bought more than 40 months ago. And even if you bought your current homestead within the 40 months, the limitation does not apply if it’s your farm residence.
HOW DOES THE FELONY LIMIT TO THE HOMESTEAD EXEMPTION WORK?
It’s both much more limited and broader than might appear.
It’s very limited because it applies only to one very specific and relatively rare category of felony convictions. The bankruptcy court has to determine that the felony “demonstrates that the filing of the [bankruptcy] case was an abuse of the provisions of [the Bankruptcy Code].” Section 522(q)(1)(A).
Being convicted of a felony for abusing bankruptcy law is extremely rare. Any other type of felony conviction would not limit your right to your full California homestead exemption; it would not be limited to the $170,350 amount.
However, there is more to this statutory limit than having an actual felony conviction. It also applies if the person filing bankruptcy merely owes one of a variety of bad-act debts. Simply the existence of one of the following four types of debts would limit your homestead exemption to $170,350. Debts related to:
- violations of federal or state securities laws or regulations;
- “fraud, deceit, or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under [federal securities law]”;
- “civil remedies under [federal racketeering laws]”; and
- “any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the preceding 5 years.”
Bankruptcy Code Section 522(q)(1)(B)(i-iv).
The first and third of these are relatively rare. The second and fourth are more common. The second potentially applies to anyone who owes a debt related to intentional financial wrongdoing. It does not require any criminal conviction, much less a felony conviction. It does not even seem to require a civil court judgment. The fourth goes beyond criminal intent to include even a debt from “reckless misconduct” causing “serious physical injury.”
But remember again: these circumstances would result not in the loss of the homestead exemption but rather only limiting it to the $170,350 amount. Furthermore even this limitation “shall not apply” if and to the extent that a bankruptcy judge would be convinced that the home equity “is reasonably necessary for the support of the debtor and any dependent of the debtor.” Bankruptcy Code Section 522(q)(2).
HOW ABOUT THE THIRD LIMITATION, RELATED TO ASSETS DISPOSED OF DURING THE LAST 10 YEARS?
It reduces the otherwise applicable homestead exemption to the extent that the home equity came from certain inappropriate sources—certain kinds of previously disposed assets.
At the outset note that here the limitation of the homestead exemption is not to the $170,350 fixed amount that applied to the first two limitations discussed above. Rather the usually applicable homestead exemption gets reduced by whatever amount the home equity is traceable to certain sources. Bankruptcy Code Section 522(o). So the reduction could be either much greater or lesser, depending on the circumstances.
For example, if you’d otherwise be entitled to a $600,000 homestead exemption, but $100,000 of that is traceable to inappropriate sources, then your homestead exemption would be reduced to $500,000. Similarly, if $550,000 is traceable to inappropriate sources then the applicable homestead exemption would be only $50,000.
WHAT ARE THESE INAPPROPRIATE SOURCES THAT WOULD REDUCE A HOMESTEAD EXEMPTION?
These inappropriate sources of value or equity in your homestead are traceable to the debtor’s prior disposal of certain property. Three conditions must be met for the property disposal to be inappropriate: it’s a matter of timing, intention, and lack of an applicable property exemption.
Timing: the disposal of property happened during the 10 years before the bankruptcy filing.
Intention: “the debtor disposed of [property] . . . with the intent to hinder, delay, or defraud a creditor.” Bankruptcy Code Section 522(o). So sales or any other transfers of assets without the intent, essentially, to hide the proceeds from creditors, are not included. Use of such proceeds as a down payment, for example, on your present home does not reduce your homestead exemption.
Lack of applicable property exemption: no property exemption would have applied to the property disposed of, at the time of the disposal. If whatever you sold or gave away would have been hypothetically covered by a property exemption at that time, the proceeds put into your present homestead from that prior property disposal would not be considered inappropriate now for purposes of reducing your homestead exemption.
All three conditions must be met for this exemption limitation to kick in. The property disposal could have taken place within 10 years, and that property could have not been covered by any property exemption, but if there was no intent to hide the proceeds from creditors then having put those proceeds into your present homestead would not now reduce the amount of your allowed homestead exemption. Or if the requisite intent was present but the disposed property was covered by a property exemption, same thing.