Home Ownership and Asset Protection

One of the greatest advantages of a home investment is that, in many states, personal residences are legally protected from the claims of most creditors due to something called a homestead exemption. Hopefully, you won't be in the position to benefit from this advantage, but it is just another reason why buying a home is such a valuable investment.

Warning Due to the complexity involved, anyone considering this course of action should seek the assistance of an attorney familiar with bankruptcy law.

Exemptions vary widely from state to state. Florida and Texas, in fact, are well known as debtor-friendly states because of their homestead exemptions. The Florida homestead exemption was once considered especially valuable because a U.S. Court of Appeals had held that the exemption would apply even when the owner acquired or enlarged it with the intent of defrauding creditors. This is no longer the case because of federal bankruptcy reform. Homesteads acquired through fraud can no longer be protected.

Federal bankruptcy reform. Federal bankruptcy law places limits on certain homestead exemptions, further complicating matters. A state's homestead exemption is limited to $125,000 if the debtor had only acquired the property's equity during the 1,215 days prior to filing bankruptcy. Property owned for more than 1,215 days is not affected by the federal law.

States with no dollar cap on their homestead exemption can limit the exemption to a certain area of land, which is much larger in rural areas. For example, in Florida the exemption is limited to different acreage depending on whether the location is in a city or elsewhere. In practice, this area limitation will only rarely be a factor.

Most states offer exemptions between these extremes. Even here, however, it's important to note that the exemption can be anywhere along the spectrum.

Under the federal bankruptcy provisions, the homestead exemption is $21,625 (this amount may be adjusted). Where a state's homestead exemption is lower than the federal amount, if you're contemplating a bankruptcy filing you should consider using the federal exemptions (if the state law permits it), all other things being equal.

The homestead exemption is considered such a basic and important right in some states, including Florida and Texas, that it is mandated by the state's constitution. This prevents the state's legislature from modifying or repealing the exemption by statute.

Generally, consensual liens, such as mortgages, cannot be eliminated inside or outside of bankruptcy, even when they are attached to property subject to an exemption. Thus, the homestead exemption can actually be worth nothing to you if your home is very heavily mortgaged. In addition, remember that bifurcation or lien-splitting usually will not be possible in a bankruptcy proceeding with respect to mortgages secured solely be a residence.

Nevertheless, where the homestead exemption is generous (e.g., in Florida or Texas), it will probably provide the greatest opportunity to shield wealth from creditors.

Strategies to consider. To take advantage of this exemption most effectively, you may want to consider the following strategies:

• When the homestead exemption is unlimited, or the amount of the exemption exceeds the value of the home, consider paying off the mortgages on the property.
• Where the value of the home exceeds the exemption amount, consider the opposite strategy; that is, encumbering the home with an additional commercial mortgage, or a private mortgage.
• Where there is no homestead exemption or the exemption is extremely low, consider owning the home with a spouse in tenancy by the entirety if the state allows this. It's important here that you consider this option only after carefully weighing the risks of divorce.

Planning Note Some states require individuals to record their homestead exemption at the county recording office, or wherever legal documents are normally recorded in the state. If the exemption is not recorded, you may not be able to use it. In some of these states, recording must take place before a bankruptcy filing, while in others, recording must occur before a forced sale of the home. In some states, recording is optional, and may give you no greater rights than if you hadn't filed the papers. It isn't necessary to sort out all of the differences. If recording is allowed or required, you should simply record your homestead exemption. The following states allow, or require, the recording of the homestead exemption: Recordation of the Homestead Exemption Alabama Massachusetts Texas Arkansas Michigan Utah California Montana Virginia Florida Nebraska Washington Idaho Nevada   Iowa South Dakota