Chapter 13 can be an effective way to temporarily or permanently hold on to business and investment real estate equity and income.
If you own real estate that is not your home, filing a Chapter 7 “straight bankruptcy” would likely result in you losing control of what happens to that real estate. In our last blog post we showed how filing a Chapter 13 “adjustment of debts” case could give you more control over that. Often you have more control over whether the property is sold or retained, whether undesirable real estate can be surrendered to its mortgage holder, and the timing of such events.
Chapter 13 also can also much better protect equity in your real estate from your creditors. If that real estate is producing income for you, Chapter 13 can often protect that income and put it to much better use. Furthermore, because Chapter 13 is much more flexible than Chapter 7, and its protection against your creditors lasts for years instead of just a few months, it can give you the opportunity to build equity in your real estate.
More Benefits to the Real Estate within Chapter 13
—Protecting the Equity
If your real estate clearly does have equity, in a Chapter 7 case you would definitely lose the real estate to the bankruptcy trustee and its sale proceeds to your creditors. After all, Chapter 7 is a liquidation form of bankruptcy, and anything that is not protected through property “exemptions” is usually taken by the trustee and sold to pay your creditors.
Usually real estate that is not your home is not protected by an exemption (although there are possible exceptions in certain states under certain circumstances). So again you’d likely lose such property in a Chapter 7 case.
But what if you needed the real estate for your business? Or what if you had some deep personal or family connection to the real estate?
Chapter 13 allows you to keep non-exempt property under many circumstances. You may well have to pay more or longer into your payment plan to pull this off. But in some situations that may not even be necessary.
Determining whether you can keep real estate that is not exempt, and what you would have to do in a Chapter 13 case to pull that off, requires a rather complicated case by case analysis. So you need to talk about this with an experienced bankruptcy lawyer. The point here is that being able to keep otherwise unprotected real estate is much more likely under Chapter 13 than Chapter 7.
—Protecting Real Estate Income
The minute you file a Chapter 7 case the bankruptcy trustee has a right to all rents and other income from your real estate. This is true even if the trustee later decides to abandon that real estate.
In contrast, under Chapter 13 income from real estate is treated much more like your income from employment. Your income from all sources is used to determine your monthly “disposable income”—your income after expenses—and the amount you can afford to pay into your monthly Chapter 13 payment plan.
There are other considerations—such as whether you can financially justify keeping that real estate going forward. But again it’s much more likely that you would be able to keep, or put to good use, income from such real estate under Chapter 13 than under Chapter 7.
—Creating Real Estate Equity under Chapter 13
One of the ways you can justify keeping real estate in a Chapter 13 case—either permanently or to sell later in the case—is to show that you are building equity in the real estate during the course of the case. You can create equity three ways:
1. The real estate may have liens on it—for property taxes, income taxes, or child support, for example—on debts that you would be paying off during the course of the case. Paying off those debts would result in the release of the liens, building equity in the real estate relatively quickly.
2. Some liens—such as for older income taxes—many not have to paid in full or sometimes even in part. The underlying debt may be discharged—legally written off—resulting in the release of such liens, and resulting in the building of equity in the real estate.
3. If the real estate’s value is rising year over year, over the span of a 3 to 5 year Chapter 13 case equity will be created through that appreciation, along with the reduction in the mortgage’s principal balance during that time.
In a Chapter 7 case, as a liquidation form of bankruptcy that fixates on you and your real estate’s status as of the moment your case is filed, future equity is essentially irrelevant. Chapter 13 can open up opportunities to build such future equity to your benefit.