Section Review

Changes to Bankruptcy Homestead Exemptions are Already in Effect

Mr. Ruttenberg is a graduate of Yale University (B.A. summa cum laude, 1984) and Harvard Law School (J.D. magna cum laude, 1988) and is admitted in Massachusetts. He is a partner at Looney and Grossman in Boston and can be reached at [e-mail aruttenberg].
On April 20, 2005, President Bush signed legislation enacting the most extensive revisions to the bankruptcy laws of the United States since 1978. Media coverage has focused on the monolithic changes in who will be able to file a Chapter 7 bankruptcy petition once most of the new law becomes effective on October 17, 2005. Comparatively little attention has been given to the numerous changes in the laws of exemptions, which delineate the property that a person in bankruptcy can automatically keep. Unlike the restrictions on bankruptcy eligibility, many of these changes are in effect now, for any bankruptcy case filed on or after April 20, 2005. Specifically, three changes limiting the applicability of the homestead exemption will have significant impact in Massachusetts.

At least since In re Weinstein, 164 F.3d 677 (1st Cir. 1999), bankruptcy practice with respect to homestead exemptions in Massachusetts has been straightforward. Counsel for a prospective bankruptcy debtor who owned and lived at a property in Massachusetts with significant equity made sure that, prior to the bankruptcy filing, a declaration of homestead was recorded with the appropriate registry of deeds. This declaration of homestead (coupled with the debtor’s domicile in Massachusetts) made the debtor eligible to choose Massachusetts state exemptions, particularly the Massachusetts homestead exemption, rather than the federal bankruptcy exemptions. (Effective October 26, 2004, the homestead exemption of Mass. Gen. Laws c. 188, § 1 rose to $500,000, compared with the federal exemption of 11 U.S.C. § 522(d)(1) of $18,450). As long as the homestead declaration was validly of record and the debtor resided at the property, the homestead protected the first $500,000 in equity, which even in the appreciating housing market of Massachusetts meant the property was unlikely to be available for the bankruptcy estate to sell. The analysis was simple and short. All this has now changed. For cases filed on or after April 20, 2005, three new provisions, 11 U.S.C. §§ 522(o), 522(p), and 522(q), complicate matters tremendously for bankruptcy debtors.

First, 11 U.S.C. § 522(p) generally reduces the maximum amount of the homestead exemption to $125,000 for a home “that was acquired by the debtor during the 1,215-day period preceding the date of the filing of the petition.” Thus, if the deed to the debtor for the property were recorded less than 1,215 days before the petition — approximately three years and four months — then the Massachusetts homestead exemption would be $125,000 and not $500,000.

There are two exceptions to this limitation, one for family farmers and the other for an “interest transferred from a debtor’s previous principal residence (which was acquired prior to the beginning of such 1,215-day period) into the debtor’s current principal residence, if the debtor’s previous and current residences are located in the same State.” So a Massachusetts debtor who acquired a house less than 1,215 days before filing bankruptcy can still use the entire $500,000 exemption if the debtor’s interest in the house was transferred from a previous residence in Massachusetts. But if the previous residence was in New Hampshire or Rhode Island, the debtor’s exemption will be limited to $125,000. How courts will interpret the word “transferred” is unclear. Closing on the sale and the purchase simultaneously, where the money for the purchase comes from the sale proceeds, surely would be a transfer, but what about a situation where the debtor takes the sale proceeds, deposits them in a personal bank account, rents for a few months, and then buys a new house?

Second, 11 U.S.C. § 522(o) reduces the value of an interest in property that may be claimed as a homestead “to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor.” In other words, if, during the 10 years before the bankruptcy filing, the debtor committed an intentional fraudulent transfer of other property, and some portion of the value of the debtor’s residence is attributable to the proceeds of that other property, then such attributable portion of the debtor’s residence cannot be exempted. The result appears to be that if $50,000 of the value of the residence is attributable to the fraudulently transferred other property, then a bankruptcy trustee could sell the residence and keep $50,000 of the proceeds for the bankruptcy estate irrespective of what otherwise would be a $500,000 homestead exemption. How courts will interpret the word “attributable” is unclear. Will the proceeds of the other property have to be directly traceable into the residence, or will it be sufficient for a trustee to argue that the debtor wouldn’t have been able to buy or keep the residence if the debtor didn’t have the proceeds of the other property to live on?

Third, 11 U.S.C. § 522(q) reduces the maximum amount of the homestead exemption to $125,000 if the debtor has been convicted of a felony or owes certain debts. The reduction based on conviction of a felony only applies if the conviction “under the circumstances, demonstrates that the filing of the case was an abuse” of the Bankruptcy Code. The reduction based on certain debts has no such restriction, and by its literal terms applies to any debtor who owes a debt based on any violation of the securities laws, fraud, deceit, manipulation in a fiduciary capacity or in connection with the purchase or sale of any security, a judgment under the federal RICO statute, any criminal act, intentional tort, or willful or reckless misconduct that caused serious physical injury or death to another individual in the five years prior to the bankruptcy petition. Many debtors obviously could fall within this language. There is an exception to this reduction to the extent a homestead in excess of $125,000 “is reasonably necessary for the support of the debtor and any dependent of the debtor.” The application of this language to a particular case will undoubtedly be very fact specific.

Clearly, these three provisions, already in effect today, raise significant questions and have serious consequences for bankruptcy cases throughout Massachusetts.

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