Pigs, Hogs, and Nonexempt Property in Bankruptcy

Nonexempt Property in Bankruptcy: In Bankruptcy Court, it’s all about the Pigs and the Hogs.

In Bankruptcy Court, it’s all about the Pigs and the Hogs.

“There is a principle of too much; phrased colloquially, when a pig becomes a hog, it is slaughtered. While . . . some planning of one’s exemptions under bankruptcy is permitted, a wholesale sheltering of assets which otherwise would go to creditors is not permissible.”

Hon Robert Johnson, Bankruptcy Judge, District of New Mexico, In re Zouhar, 10 B.R. 154 (Bankr. N.M. 1981).

Many times, clients have come into my office wanting to file bankruptcy and are disappointed to find out that they have assets that are nonexempt.

A nonexempt asset is one that could be reached and sold by a creditor to satisfy a judgment, or could be sold by the bankruptcy trustee.

Most people do not want to file bankruptcy if they have nonexempt assets that could be sold, unless the they do not value the asset that much, or the benefits of discharging the debt far outweigh having to lose what nonexempt assets they might have.

The unfortunate thing is that much of the time, the same value of assets could be fully protected if it were, say, $75,000 sitting in an IRA rather than a $75,000 parcel of real estate held as an investment. Why not just sell the land and plop it in your IRA and then file bankruptcy the next month? Well, that would be unlikely to work, as it would be grounds for denying the discharge (for destroying an asset that could go to creditors) or perhaps allowing the Trustee to invade the IRA as a “fraudulent conveyance.”

However, at the time this blog post was written, the current Chief Bankruptcy Judge in the District of New Mexico had recently written an opinion stating that putting $10,000 in an IRA right before filing bankruptcy is permissible, because that was the annual limit that Congress authorized for a tax-free deposit, so it consistent with federal policy.

This is called “exemption planning,” and it is often perfectly appropriate. Other asset protection mechanisms are also appropriate when done as a long term stratagem. After all, exemptions exist for a reason, and having assets held in exempt property is encouraged and hardly immoral or illegal.

There are numerous other examples that are limited only by the imagination of the parties and their lawyers.

Here is one:

Since a married couple has $120,000 homestead exemption in New Mexico, how about selling those stock certificates from the safety deposit box, and paying the mortgage down a $100,000 and then filing for bankruptcy? Since annuities are exempt under New Mexico law, why not take that $50,000 that was just inherited from grandpa, purchase an annuity, and then file for bankruptcy?

None of those would be likely to work as described. However, similar transactions could be successful if done gradually over time, giving the transactions time to “season” prior to filing so that the Court would not view it as a bad faith manipulation of the system. Asset protection also looks better to the courts if the assets are sheltered before creditors start pounding at the door.

So what is the way to do it without getting in hot water with a bankruptcy judge as bad faith exemption planning?

How long should the transaction season?

Unfortunately, I have to tell my clients it all depends on whether the judge looks at you and sees a pig or a hog.

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