When you file for personal bankruptcy, you will have to decide whether to use Chapter 7 or Chapter 13. If you own investment property, this choice will have significant consequences. In Chapter 7, you will have to give up any property you own that isn't protected by an exemption, which almost always includes investment real estate. If you have significant equity in this property, the trustee can take it, sell it, and distribute the proceeds to your creditors (after paying off the mortgage and any other loans or liens on the property). In Chapter 13, you can keep all of your property -- but you'll have to repay a portion of your debts in a three- to five-year repayment plan.
In Chapter 7, you won't lose any property that's protected by an exemption. Exemptions are determined by state law (or federal law, if your state allows you to choose between the state list of exemptions or the federal list). Exemptions typically protect needed items such as a car, clothing, furniture, tools of the trade, and at least some equity in a home. However, homestead exemptions apply only to your residence, not to property you own as an investment, such as rental property. Investment real estate is generally not exempt, and could be lost in Chapter 7. (For more information on exemptions, and links to each state's rules, see Bankruptcy Exemptions - What Do I Keep When I File for Bankruptcy?)
If you are underwater on your investment property loans -- that is, you owe more than the property is worth -- and you are willing to give it up, Chapter 7 might not be a bad choice. The trustee won't take the property, even though it's exempt, because any money earned from a sale would go to those holding liens and loans on the property, with nothing left for your other creditors. However, in Chapter 7, you get to decide how you want to handle your secured debts, including those secured by your investment property. One option is to simply surrender it to your creditors. Surrendering the property eliminates your liability for the debt, even if you owe more than it's worth. Any amount you owe that exceeds the value of the property will be discharged (wiped out) in your bankruptcy case.
If you have some equity in the property, however, you might well lose it in Chapter 7. Even if you tell the court that you'd like to keep the property by reaffirming the loan or continuing to make your payments, the trustee might take it and sell it if doing so would raise some real money for your other creditors.
By using Chapter 13, you can keep your investment property. In Chapter 13, you don't have to give up any property. Instead, you must repay a portion of your debts over time, in a Chapter 13 repayment plan. Your investment property will still play a role in your bankruptcy case, however, in the following ways:
If you have valuable investment property that you want to keep, consider a consultation with an experienced bankruptcy attorney. An attorney can explain your options and help you choose the strategy that makes the most sense in your situation.