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Posted May 3, 2002

Home Equity-Bankruptcy Controversy Resolved

The most contentious and longest-running real estate issue pending on Capitol Hill--simmering for years--has now been resolved: Wealthy Americans no longer will be able to protect their financial assets in bankruptcy by buying luxury homes at high prices in "unlimited homestead exemption" states such as Florida and Texas.

Negotiations between House and Senate conferees on long-stalled federal bankruptcy legislation have finally produced a compromise designed to bridge the gap between states' rights, on the one hand, and creditors demands for nationwide bankruptcy law reforms on the other.

Under the compromise, individuals filing for federal bankruptcy law protection from creditors will have to own a residence in a state for at least 40 months if they wish to use that state's "homestead exemption" provisions. Under existing law, debtors in Florida, Texas, Kansas, Iowa and South Dakota can shield an unlimited amount of home equity from creditors by filing for federal bankruptcy protection. Their home equity, in other words, is off-limits to creditors, no matter how much they owe.

Other states limit the homestead exemption by widely varying amounts. Under the new federal bankruptcy reform package, if passed by both houses and signed into law, the federal limit would be $125,000.

Bankers have sought to pre-empt unrestricted state homestead exemptions for home equity, arguing that they can be easily misused. For example, a wealthy businessman facing potentially heavy court judgments currently can make a quick move to an unlimited- exemption state, buy a $10 million mansion for cash, and protect every penny of it from creditors by filing for bankruptcy. As long as the man's assets are in home equity, they are shielded.

Bankers argue that states like Florida and Texas provide safe havens to individuals who exploit their homestead exemptions to avoid paying back money they owe to business partners, malpractice victims, lenders, and former employees elsewhere. Representatives of unlimited homestead exemption states argue in response that protection of debtors' homes is an essential feature of their constitutional histories, and should not be superseded by federal dictates.

The compromise reached on Capitol Hill would require individuals such as the hypothetical businessman above to own his home as a state resident for 40 months or more before filing for bankruptcy protection and using the state's unlimited homestead exemption.

Residents who owned their homes for less than the required 40 months would be allowed only to protect $125,000 of home equity from creditors through a bankruptcy filing. Homeowners who have been convicted of a felony or securities law crimes anytime during the preceding 10 years would be prohibited from using the state's unlimited homestead exemption, provided the bankruptcy court could establish a link between the debtor's crime and the declaration of bankruptcy.

With the long-stalled homestead issue now behind them, congressional conferees have only one remaining knotty issue to dispose of before sending bankruptcy reform legislation (H.R. 333, S.420) back to both houses: A fight over whether perpetrators of abortion clinic violence should be able to discharge judgments against them through bankruptcy filings.

Though congressional experts would not hazard a guess on the timing of the final conference report, House Judiciary committee chairman Rep. James Sensenbrenner (R-Wis.) called it "within reach." Once approved by both houses, the package will go to President Bush, who had hinted at a possible veto over the homestead issue in the past, but is now expected to sign.


Written by Kenneth R. Harney
Copyright © 2002 Realty Times. All Rights Reserved.