In the 2005 amendments, Congress blocked so-called exemption planning by prospective debtors who would fraudulently use nonexempt assets to increase the value of a homestead exemption. Interpreting the plain language of the statute, the Eighth Circuit Bankruptcy Appellate Panel handed down an opinion placing a heavy burden of proof on a trustee attempting to invoke Section 522(o) and trim down a fraudulently inflated homestead exemption.
Before the amendment, a debtor might use nonexempt property, perhaps proceeds from an investment or cash from a checking account, to pay down a mortgage, thus increasing the value of a homestead exemption in states where the exemption is generous. To halt the practice, Congress adopted Section 522(o), which provides that the value of a homestead exemption “shall be reduced to the extent that such value is attributable to any portion of any [nonexempt] property that the debtor” used within 10 years of bankruptcy “with the intent to hinder, delay, or defraud a creditor.”
The debtors scheduled a home with a $133,000 mortgage as having a value of $200,000. They claimed that the entire equity of about $67,000 was exempt.
The trustee objected to the homestead exemption, alleging that the debtors had fraudulently used between $70,000 and $90,000 before bankruptcy to improve the home and increase the value of their exemption. Ruling in favor of the trustee, the bankruptcy court in substance disallowed the exemption entirely by reducing the value by the amount spent on improvements.
The debtors appealed and won in an opinion on Jan. 24 authored by Bankruptcy Judge Charles L. Nail, Jr., of Sioux Falls, S.D.
The trustee contended that the bankruptcy court properly reduced the exemption by the value of exempt assets invested in the home. Judge Nail disagreed, reversing the bankruptcy court and saying that the lower court ignored the words “attributable to” contained in Section 522(o).
Judge Nail said the trustee had the burden of proving how much of the value of the homestead was attributable to the investment of nonexempt assets. Simply showing that the investment was made with “actual intent” is not enough.
In a dispute involving Section 522(o), the trustee must prove the value of the home both with the investment and without. Required to employ the “plain meaning” of the statute, Judge Nail rejected the trustee’s argument that his construction would “place too heavy a burden on trustees.” He also said that his interpretation of the statute would not lead to an “absurd result.”
Likewise, he said that the result from a proper statutory interpretation would not be “monstrous,” because a debtor “will not reap any benefit from his wrongdoing” given that proof of a fraudulent transfer “with actual” intent will result in the denial of discharge, which is what happened in the case in parallel litigation.
Judge Nail noted that some fraudulent transfers of nonexempt property will result in dollar-for-dollar reductions in a homestead exemption. He said that making a down payment or paying down a mortgage with nonexempt property could reduce a homestead exemption by an equivalent amount.
On the other hand, Judge Nail said in a footnote that a trustee must show that the increase in value was due to the improvements, not from market appreciation.
In the 2005 amendments, Congress blocked so-called exemption planning by prospective debtors who would fraudulently use nonexempt assets to increase the value of a homestead exemption. Interpreting the plain language of the statute, the Eighth Circuit Bankruptcy Appellate Panel handed down an opinion placing a heavy burden of proof on a trustee attempting to invoke Section 522(o) and trim down a fraudulently inflated homestead exemption.