Many people file bankruptcy to get a fresh start financially, and bankruptcy laws exist to help balance your need to get back on your feet with your creditors’ need to be paid. Special bankruptcy rules apply to sales or transfers of certain assets, such as a home, that occur before or during the bankruptcy case.
Chapter 13 bankruptcy involves a repayment plan whereby you repay some or all of your debt over a period of three to five years. Unlike Chapter 7 bankruptcy, Chapter 13 does not involve liquidation – or sale – of your assets. Rather, you make payments of a portion of your income to a bankruptcy trustee who then pays your creditors in accordance with the terms of your repayment plan. At the end of your repayment plan, remaining unpaid debts are often discharged.
The payments you make under your repayment plan are based on your disposable income, which is your monthly income less certain allowable expenses such as food and fuel. Windfall income – a large, irregular sum of money – such as income from the sale of a house can be considered disposable income, too, even though it doesn’t come on a regular schedule. If you can show your trustee that you need that money for an allowable expense, such as a down payment on another house, you may be able to keep the money. Otherwise, the trustee may be able to take it to pay your creditors.
Using the Money
Depending on the amount of time between the sale of your home and your bankruptcy filing, you’ll probably have to disclose the sale to your bankruptcy trustee. The trustee may request an accounting of how you spent the proceeds of the sale. The trustee may also need to verify that you sold the house for a fair value, rather than transferring it to a family member or friend for less than its value. This could be considered a fraudulent transfer and could cause problems in your bankruptcy proceeding. Even if you did not fraudulently transfer your home, some of your profit on the sale could be used to help pay your debts. If you used the proceeds from the sale to pay off only certain creditors, such as family members, your trustee could demand the return of the money so that he can more evenly distribute the proceeds among your unsecured creditors.
In a short sale, you get your lender’s approval for the sale of your home for less than you owe to your lender. When your house sells, your unpaid mortgage debt – now not secured by collateral – becomes unsecured debt that is dischargeable in the bankruptcy proceeding. A short sale may allow you to qualify to buy another home sooner than if you allowed a foreclosure on your home.