Do you own rental property? If you own a house, an apartment, commercial space, or a multi-unit building that you rent out to tenants, then you should consider how it will be affected if you file for bankruptcy. Whether you get to keep the property may depend on whether you file under Chapter 7 or Chapter 13.
How Rental Property Is Treated in Chapter 7
When you file for bankruptcy under Chapter 7, you get to keep any property that's "exempt" under state law (or under federal law, in states that allow filers to choose between the state's exemption system or the federal exemption system). Most states protect at least some equity in a home. Some states exempt only up to a certain dollar amount; other states are more generous, and protect a filer's entire interest in a home. (Learn more about exemptions -- and find links to every state's exemption lists -- in Bankruptcy Exemptions --What Do I Keep When I File for Bankruptcy?)
No matter how much equity your state's law protects, however, it applies only to your residence: the home in which you live. It doesn't protect other property you own and don't use as a residence, such as rental property. Because your rental property is almost certainly not exempt, the bankruptcy trustee can take it, sell it, and distribute the proceeds to your creditors.
The trustee will take nonexempt property only if the proceeds from selling it will significantly exceed the costs of taking and selling it. So, if you have little or no equity in your rental property, the trustee may choose not to take it. In this situation, the mortgage holder would be entitled to all or most of the proceeds from the sale, leaving nothing for your other creditors.
If you have a relatively small amount of equity in your rental property, you may be able to protect it with a "wildcard" exemption: an exemption amount that you can apply to any property. Not all states have a wildcard exemption; in those that do, the amount you can protect is typically small (often in the hundreds of dollars). However, some states have higher wildcard exemptions. If your equity is minimal, using a wildcard exemption may tip the scales in your favor and make the trustee less likely to take your rental property.
How Rental Property Is Treated in Chapter 13
When you file for Chapter 13 bankruptcy, you don't have to give up any of your property. Instead, you use your income to repay some or all of your debts, over a three- to five-year repayment period. So you don't face the danger of having your rental property taken and sold by the trustee.
However, your rental property will affect your Chapter 13 bankruptcy case in a couple of ways. First, it may require you to pay back a substantially larger portion of your debt. When you file for Chapter 13, the amount you pay your creditors must be at least equal to the value of your nonexempt property. This rule is intended to make sure that your creditors won't be worse off if you use Chapter 13 than they would have been if you had used Chapter 7. If you have significant equity in your rental property, you will have to repay your creditors at least this much in your plan.
Second, you can include any arrearages you owe on your rental property in your Chapter 13 plan. For example, let's say you've missed a couple of mortgage payments on a home you rent out, at $1,000 each. You can include that $2,000 in your repayment plan, paying off a little each month. As long as you can continue making your payments, you can avoid foreclosure.
Third, you may be able to "cram down" your mortgage on rental property. This means you can reduce the amount you owe to the value of the property at the time you file for bankruptcy. For example, if you owe $200,000 on a rental home that's worth only $100,000, you can reduce your debt to $100,000. Although you generally can't cram down a mortgage on your residence, this remedy is available for certain types of rental property. There is a major catch, however: You must pay off the full amount you still owe in your repayment plan. Using our example above, this means you'd have to pay off $100,000 during the three to five years you are in Chapter 13 bankruptcy. Repaying such a large amount in such a short period of time is next to impossible for most people, particularly those whose debt problems have already led them to bankruptcy.
Do You Need a Lawyer?
If you have rental property you really want to keep, you might consider consulting with an experienced bankruptcy attorney in your state to learn what options are available and which strategy would best protect your investment.