Myth: A debtor exemption makes purchasing a bankruptcy asset more complicated or impossible.
Every person that files for bankruptcy or has a judgment awarded against them in a lawsuit is entitled to certain property exemptions, or the value of the property the debtor may retain. Exemptions are determined by the state law where the person resides. For homeowners, the most important would be the homestead exemption which can be used to protect a home from a forced sale. However, some states, like Nevada, include a wildcard, or a predetermined amount that can be applied to any asset in their case.
The most commonly misunderstood rule of exemptions is that the exemption applies to only the value or equity of an asset, not necessarily the asset itself. For example, a debtor in Nevada may elect to apply their $1,000 exemption to a parcel of vacant land in their possession. This does not mean the debtor will automatically retain the land itself; rather, the debtor retains a right to $1,000 of the equity of the land. The US Bankruptcy Court appointed Bankruptcy Trustee can sell the land at auction, and pay the exemption out of the proceeds. Thus, if our hypothetical parcel sold for $5,500, the debtor would receive $1,000 and $4,500 would go to the bankruptcy estate to be divided amongst the creditors. Trustees often use the debtor exemption as a minimum amount to start bidding on a bankruptcy asset. Bidding on the hypothetical parcel of land may have started at $2,000–$1,000 to cover the debtor’s exemptions and $1,000 for the bankruptcy estate.
Exemptions differ by Region, District, and State. The exemptions of the state where the bankruptcy was filed usually apply, however in certain circumstances, other exemptions may apply. Review the bankruptcy code here.