Some people find the idea of "being their own boss" to be more attractive than working for an established company. Small business owners do this by opening a restaurant or boutique, but some choose to pursue real estate as a way of building wealth. But with the recent economic downturn, what happens to investment property if the owner has to file for bankruptcy? Can a debtor keep rental property if they are going through bankruptcy?
Qualifying for Bankruptcy as a Property Owner
Financial means does not determine who files bankruptcy: a person living on $30,000 a year may have the same eligibility for filing bankruptcy as someone making $300,000 a year. Bankruptcy courts take each person's income, assets, and debts into account when a debtor files for bankruptcy. These elements give some idea of the debtor's ability to pay creditors.
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How is Investment Property Treated in Bankruptcy?
Investment property is often used as rental property, and because of that, it is treated differently according to which bankruptcy chapter the debtor is filing.
Consumers typically file chapter 7 bankruptcy or chapter 13 bankruptcy. Chapter 7 bankruptcy discharges many debts and offers a fresh start for the debtor, so there are strict requirements. To determine whether the debtor makes enough money to pay off their debt in a reasonable amount of time, the bankruptcy court administers a "means test." If the court finds that the person filing for bankruptcy makes more than their state's average income and has a low cost of living, then they do not pass the means test. This means that the debtor has to pursue filing for chapter 13 bankruptcy, which allows them to reorganize their debt so they can pay it back over a three to five year period with court approval.
Exempt vs. Non-exempt Assets
Chapter 7 bankruptcy is designed for individuals who do not have a steady source of income. Once the debtor determines that their debt is out of control, the court appoints a trustee to liquidate their non-exempt assets so that the money from those sales can be used to pay off outstanding debts. What is exempt from liquidation in chapter 7 bankruptcy? The debtor is usually allowed to keep possessions that provide for basic needs, such as a home, car, and furniture. Their non-essential assets, however, are sold.
If you own investment property and plan on filing for chapter 7 bankruptcy, you may not be able to keep that property. Even if it is used as rental property, your situation may be subject to United States Bankruptcy Code 541, which states that "proceeds,...rents, or profits of or from property of the [debtor's] estate" are included in their overall estate. This means that if you rent your property and earn an income, it is likely counted as non-exempt property.
Debtors dealing with chapter 13 bankruptcy are not required to liquidate their property. The issue concerning investment property in filing chapter 13 bankruptcy, however, comes with the means test. If the court feels that you have enough assets to settle your claims on your own, they may not approve your claim. However, you may be able to show the court that your investment property also brings you a steady income if you use it as a rental property. The court may see it as a necessary piece of property in your plan to repay certain debts, so in this case, it won't be considered a personal asset.
Small Business Owners and Bankruptcy
Investment property is a concern for many entrepreneurs and small business owners who are considering bankruptcy. Many times, their personal finances are closely tied to the business's finances, and it can be difficult to confront the fact that bankruptcy may be inevitable. You may be able to keep investment property during bankruptcy proceedings, however.
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