Proceeds from the sale of a homestead may be exempt under the laws of some states, but not under federal exemptions, even when proceeds are exempt in that state, according to Bankruptcy Judge Charles R. Merrill of Louisville, Ky.
Judge Merrill decided that state exemption law should play no role in defining the contours of the federal homestead exemption in Section 522(d)(1). Should there be an appeal, the district court might analyze whether or not federal courts should make federal common law in aspects of the federal homestead exemption that are not defined in the Bankruptcy Code. Cf. Rodriguez v. Federal Deposit Insurance Corp., 40 S. Ct. 713, 206 L. Ed. 2d 62 (Sup. Ct. Feb. 25, 2020).
Home Sold Before Bankruptcy
The debtor sold her home six days before filing a chapter 7 petition. She deposited the net proceeds, about $23,000, into her bankruptcy attorney’s trust account. The debtor elected federal exemptions and claimed a homestead exemption in the proceeds under Section 522(d)(1).
In an opinion on January 10, Judge Merrill sustained the trustee’s objection to the exemption claim.
Section 522(d)(1) provides for a federal exemption of about $25,000 “in real property or personal property that the debtor or a dependent of the debtor uses as a residence . . . .”
The debtor pointed out that Kentucky law allows a homestead exemption in identified proceeds from the sale of a home. Judge Merrill was not persuaded to follow state law. Because the debtor had claimed the federal exemption, he said that “the state exemptions are rendered inapplicable.”
As a matter of fact, Judge Merrill found that the debtor “did not have any interest in her former residence once she filed bankruptcy.” As a result, she “could no longer claim a homestead exemption in that property, or in the sale proceeds.”
Unlike some state exemption statutes, Judge Merrill said “there is no language in 11 U.S.C. § 522(d)(1) that would permit the exemption of the proceeds from the prepetition sale of the Debtor’s homestead.” The statutory language, he said, “is clear and unambiguous in this instance, vesting no exemption power in the proceeds arising out of the pre-petition sale of a debtor’s homestead.” [Emphasis in original.]
“Applying the ‘snapshot rule’ to the facts here,” Judge Merrill said it was “clear that the Debtor completed the transfer of [the former residence] prior to seeking bankruptcy relief, and thus on the date of her petition, she did not have a homestead to which she could apply the § 522(d)(1) exemption.”
Federal Common Law
Writing for the unanimous Supreme Court in Rodriguez, Justice Neil M. Gorsuch said that “cases in which federal courts may engage in common lawmaking are few and far between.” Rodriguez, supra, 40 S. Ct. at 716. He said that “only limited areas exist in which federal judges may appropriately craft the rule of decision.” Id. at 717.
Of perhaps greatest relevance to the homestead exemption case, Justice Gorsuch said that federal common law is appropriate only when “necessary to protect uniquely federal interests.” Id.
Rodriguez was cut from the same cloth as Butner v. U.S., 440 U.S. 48, 55 (1979), where the Supreme Court said:
Property interests are created and defined by state law. Unless some federal interest requires a different result, there is no reason why such interests should be analyzed differently simply because an interested party is involved in a bankruptcy proceeding.
Compared to the homestead exemption, Rodriguez involved a different property interest: whether federal common law or state law determines the ownership of a tax refund among a group of affiliated companies that filed a joint tax return. Although Rodriguez is not on point, does the decision suggest that bankruptcy law should be informed by state law when a concept or term is not fully defined in the Bankruptcy Code? To read ABI’s report on Rodriguez, click here.
Section 522(d)(1) governs the amount of a federal homestead exemption, regardless of whether the state exemption would be more or less. Similarly, Section 522(d)(1) would extend the federal exemption to cooperatives, personal property and property used by a dependent even if it were not so under the state exemption.
Judge Merrill was on solid ground in holding that proceeds were not exempt, because Section 522(d)(1) refers to “real property or personal property that the debtor . . . uses as a residence . . . .” At the time of filing, the debtor was not using the $23,000 as her residence, but perhaps she would have used the proceeds to buy a new residence if the exemption were upheld.
Arguably, Section 522(d)(1) is not explicit about proceeds. If the federal statute is not explicit, why not draw the contours like they would be under state law?
States have abundant statutory and interpretive law defining the homestead exemption. Why not allow state law to determine the outcome except in those aspects where Section 522(d)(1) is explicit?
Update
The day after Judge Merrill handed down his decision, the debtor amended her Schedule C to claim a wildcard exemption in almost half of the proceeds under Section 522(d)(5).
Proceeds from the sale of a homestead may be exempt under the laws of some states, but not under federal exemptions, even when proceeds are exempt in that state, according to Bankruptcy Judge Charles R. Merrill of Louisville, Ky.
Judge Merrill decided that state exemption law should play no role in defining the contours of the federal homestead exemption in Section 522(d)(1). Should there be an appeal, the district court might analyze whether or not federal courts should make federal common law in aspects of the federal homestead exemption that are not defined in the Bankruptcy Code.