In 2005, the Bankruptcy Code was amended to stop people from using the "mansion loophole." The mansion loophold was the ability of people in states that have low-exemptions to take a large pile of cash that would otherwise be seized by creditors, and move to Texas and buy a mansion, move into it and claim it as homestead, and then file bankruptcy to get rid of their debts.

Now, after the amendments to the Bankruptcy Code, if a person moves to Texas and buys an expensive home, to have the "unlimited" homestead exemption provided by Texas law (10 acres in an urban area, 100 acres single or 200 acres family in a rural area, with all improvements), a bankruptcy cannot be filed for 1215 days, about 3 years and 4 months.

If they file sooner than 1215 days, a bankruptcy trustee can sell the house, and give them the amount of equity that they can protect, which is currently $146,450 (the exact amount changes with inflation).

In a recent case decided by the 5th Circuit Court of Appeals, a California couple purchased a $1 Million dollar Texas homestead, and two years later a creditor obtained a $5 Million judgment against the husband. In the Matter of Kim, 5th Cir. Court of Appeals, 2014.

The creditor then filed an involuntary bankruptcy against the husband (this is unusual, but if there is enough money at stake, it is certainly possible). The house was purchased less than 1215 days before the filing of the bankruptcy, so under Section 522(p) of the Bankruptcy Code, the husband's exemption was limited to $136,875 in equity (the limit at the time).

The husband then sued for a declaratory judgment in Bankruptcy Court, asking the court to determine that the house could not be sold because his wife had an interest in it, or in the alternative, that she must be compensated for the loss of her homestead interest in the property.  

The bankruptcy court held that the non-debtor spouse's homestead rights were limited to the dollar amount of the exemption in 11 U.S.C. 522(p) ($136,875) and that there was no unconstitutional taking of the value of the non-debtor spouse's interest in the homestead. The 5th Circuit court affirmed the district court's affirmance of the bankruptcy court's holdings.

So the lesson here is if you are going to be sued, protect yourself ahead of time. I can't tell from the court case, but it appears that Mr. Kim was in debt trouble before he moved to Texas. If he had moved sooner, and the 1215 days had run, he would have been all right.

In any event, he converted the case to chapter 11, and hopefully will be able to keep the home, but likely have to pay the creditor at least what they would have received in chapter 7. Do you think this was the correct result? Any other comments or thoughts about this case or Sec. 522(p) of the Bankruptcy Code?

J Thomas Black
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Board Certified, Consumer Bankruptcy Law- Texas Board of Legal Specialization
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