One of the more paradoxical effects of the Pandemic has been the resulting substantial increase in values of residential real estate. Home prices in many areas have increased by 25% or more in just a matter of months. Anecdotally this appears to be the result of many individuals deciding to flee urban centers to more suburban or ex-urban areas – especially if remote work environments are here for the foreseeable future.
Unless the sale of the real estate was anticipated, this may not be the boom to homeowners one might think. If bankruptcy is being contemplated as a result of work layoffs or debt assumption during the Pandemic (or already recently filed), it in fact can be quite problematic. The issue depends in large measure upon the value of the homestead exemption (the amount of equity a bankruptcy debtor can protect from creditors) available in bankruptcy. While bankruptcy is primarily based on federal and not state law, the debtor’s property interest are first viewed under the particular state law. Some states (i.e. Florida) have an unlimited homestead exemption which allows an unlimited amount of equity to be protected under most circumstances. A bankruptcy debtor can normally access those state’s protective laws in bankruptcy (11 U.S.C. § 522(b)(3)).
However, some states (such as New Jersey where we are located) have virtually no homestead exemption which causes most bankruptcy filers here to resort to the basic federal protections available to debtors under 11 U.S.C. § 522 (b)(2). This allows each owner to protect only $ 25,150 (this amount automatically increases marginally every third year). In a basic Chapter 7 filing, one would consider the fair market value, subtract the potential costs of a hypothetical sale (normally around 10%), the balance owed on any mortgages or other liens, and then take the available exemption. If there is remaining equity, the property can be sold by the Chapter 7 trustee to pay those funds to creditors. This is the situation nearly every bankruptcy debtor tries at all costs to avoid- but the rising value of real estate is making it far more difficult. Trustees are increasingly getting their own brokers to get up to minute valuations and arguing that the property should be marketed to obtain monies for the benefit of creditors.
This situation is compelling more consideration of Chapter 13 filings, where the available equity for creditors in a potential Chapter 7 (called the “liquidation threshold”) can be paid out over a 3-5 year plan and the property preserved. However, the rising values will increase that amount to be paid and any Chapter 13 plan must be feasible – the debtors must have the capacity to pay these funds. Alternatively, it may be possible to pay a smaller amount but agree to refinance the property (the rising values do make this option more accessible) within a time certain. In the end, the creditor must receive in any bankruptcy that which they would have received in a potential Chapter 7 liquidation. (11 U.S.C. § 1325 (a)(4)).
Anyone anticipating a bankruptcy filing who owns real estate must seriously examine this issue before filing. The true value of the real estate must first be ascertained and reliance upon online valuation services can often be misleading (good or bad). Even realtor CMA’s may not be sufficiently accurate. We are encouraging our clients to engage the services of a qualified certified appraiser before filing to minimize the potential for any surprises and ensure the proper Chapter of Bankruptcy is filed to protect the asset. Failure to accurately examine the increase in value of real estate can result in the loss of the property.