Chapter 7 bankruptcy's homestead exemption applied to residence in trust

If a consumer faces overwhelming debt, a Chapter 7 bankruptcy may provide relief. While such a bankruptcy may require the selling off of assets, the bankruptcy process also allows for "exemptions"-that is, exceptions for certain property which the debtor may retain, even through the bankruptcy.

One such exemption is the "homestead exemption," which allows some protection related to the debtor's residence. A creditor objecting to the exemption bears the burden of proving the exemption should not apply.

A recent Ohio bankruptcy case, In re Starr, decided by the United States Bankruptcy Court, provides an example.

Who really owned the residence?

The debtor filed a Chapter 7 case and in her disclosure of assets, she listed ownership of her residence. She valued the property at $260,000. At the time of filing the case, Ohio law provided for a $20,200 exemption (which has since been raised to a $125,000 exemption by an amendment to the law).

The debtor also disclosed the existence of a trust, valued at $0, in which she was the trustee and one of the beneficiaries. Unfortunately, contrary to the representations in the listings of her assets, it was the trust, and not the debtor, who technically held title to the residential real estate.

The creditor-bank therefore objected to the debtor applying a homestead exemption to her property, arguing that the debtor's transfer of the real estate into the trust left her with no "personal" interest in the real estate.

Did the homestead exemption apply?

The court noted that exemptions serve to assist in a debtor's fresh start, affording the debtor life's basic necessities. At issue in this case was what type of property "interest" qualified for protection.

The court stated that the bank's argument against the exemption completely ignored the fact that in a trust, the trustee (and not the beneficiary) holds legal title to the assets of the trust. Here, the debtor was the trustee, and her power as trustee effectively passed the legal interest in the property to the bankruptcy trustee.

Therefore, the bank failed to carry its burden of proof that the exemption did not apply to the debtor's interest in the real estate. Considering the nature and extent of the debtor's interest in the property as trustee, and the liberal interpretation favored for exemption statutes, the court found the debtor's interest in the property was sufficient to permit her claim of exemption.

Choose the type of bankruptcy that is best for your situation

What type of bankruptcy proceeding is best for an individual will depend on that person's financial situation, the type of debts involved, and the exemptions available, among other things. Many debtors find that a Chapter 7 bankruptcy proceeding is the best option for their situation, since it relieves most debt. Although nonexempt property must be sold, some exceptions, like the homestead exemption, may still apply.

If you are contemplating a bankruptcy proceeding, seek an experienced attorney who can help you choose the approach that best suits your needs, and who will provide proactive representation in the matter.