Rasmussen Court Allows Both Spouses $125,000 Exemptions and Protects Appreciation Within 1,215 Days of Bankruptcy
Since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), courts have interpreted the limitations that BAPCPA placed on homestead protection. With the exception of the Bankruptcy Court for the Arizona District,1 the courts have uniformly held that, even for residents of states that have chosen to “opt out” of the federal bankruptcy exemptions, debtors may not exempt any amount of homestead property exceeding $125,000 in value if the property was acquired by the debtor during the 1,215-day period preceding the date the bankruptcy petition was filed.2
On September 8, 2006, in In re Rasmussen, 2006 Bankr. LEXIS 2176 (Bankr. M.D. Fla. 2006), the Bankruptcy Court for the Middle District of Florida followed the line of cases holding that the $125,000 exemption applies in Florida. Rasmussen, however, addressed three additional issues: 1) Do a husband and wife each benefit from the $125,000 exemption; 2) is equity derived solely from post-purchase appreciation of the homestead an interest that was acquired by the debtor during the 1,215-day prefiling period3 if the homestead was acquired less than 1,215 days before the bankruptcy petition was filed; and 3) is equity in the homestead attributable to exempt assets used by a debtor to acquire a new homestead within the 1,215-day prefiling period, other than equity proceeds from the sale of a prior homestead within the same state, protected?4
Facts
The debtors in Rasmussen, who were husband and wife, bought their homestead in 2002 for approximately $350,000. Of the purchase price, $35,000 was rolled over from the husband’s previous homestead, and most of the remainder was from bank financing. Before the 1,215- day prepetition period had run, the debtors filed their Ch. 7 petitions. As of the petition date, the homestead had appreciated to $750,000 and the debts secured by the homestead totaled $575,000.
“Stacking” the Exemption
The court in Rasmussen addressed whether the $125,000 exemption should be stacked for a husband and wife who are co-filers in a bankruptcy proceeding. The court reviewed Florida law and concluded that each debtor is separately entitled to the constitutional exemptions, even if the property is jointly owned. The court also relied on current bankruptcy law, including §§522(m) and 522(p) of BAPCPA, to support its conclusion that spouses filing a joint bankruptcy proceeding should be able to stack their respective $125,000 exemptions.
Qualifying its “stacking” decision, however, the court stated that §522(m) of BAPCPA would not create rights that did not otherwise exist in state statutes. The court cited an Alabama law, which limits the homestead exemption to a single $2,000 for joint debtors, as an example of a state where debtors would not be able to utilize the “stacking” provisions of §522(m) because of state law limitations. The court noted that Florida’s unlimited homestead exemption does not contain any specific limitations on the right of either spouse to claim the homestead exemption. Based on its analysis of the Florida homestead laws and BAPCPA §522(m), the court concluded that in Florida, joint debtors should be able to “stack” their exemptions for a total of $250,000. Presumably, the court’s rationale would also be applicable in states like Florida that do not specifically limit the homestead exemption in the case of joint owners.
Can Creditors Reach Homestead Appreciation Earned During the 1,215-day Prefiling Period?
The bankruptcy trustee in Rasmussen contended the interest in homestead that the debtor acquired during the 1,215-day prefiling period included post-acquisition appreciation. In ruling against the bankruptcy trustee, the court relied on BAPCPA §522 (p)(1), which states “a debtor may not exempt any amount of interest that was acquired by the debtor during the 1,215-day period. . . that exceeds in the aggregate $125,000.”5 The court noted that there were two prior cases interpreting whether appreciation during the 1,215-day prefiling period is considered to be an “interest acquired” if the homestead was acquired more than 1,215 days before the petition was filed.6 Following the reasoning of those cases, the Rasmussen court concluded that the phrase “interest acquired by the debtor” implies more than a passive acquisition of market appreciation. Instead, the court noted, the concept of an “interest acquired by the debtor” implies an active acquisition of equity, such as a down payment or a mortgage pay down.
The court’s opinion concluded by stating, “[T]he fact that the Homestead may have appreciated substantially in value during the 1,215-day period does not constitute the acquisition of an interest in the [d]ebtor’s homestead for purposes of §522(p).”7 According to the court, its conclusion is consistent with the legislative history of §522(p), which does not contain any suggestion that a debtor’s passive acquisition or appreciation within the 1,215-day prefiling period was intended to be subject to the §522(p) cap. The court reasoned that “[p]assive appreciation in homestead was not the target of the [federal bankruptcy] legislation; rather, the active acquisition of equity in an exempt homestead shortly before filing for bankruptcy was the focus. . . . ”8 Example one below illustrates how a bankruptcy court might apply these concepts in future cases.
The Rasmussen court also commented on the phrase “aggregate of $125,000 in value” as used in BAPCPA §522(p), stating the phrase implied that successive acquisitions of equity during the 1,215-day prefiling period should be aggregated in calculating the $125,000 cap. In a footnote, the court noted that this calculation would include monthly principal amortization from mortgage pay downs, but noted that such amounts would rarely ever exceed the exemption amount utilizing a conventional 30-year mortgage.9 Those utilizing 15-year mortgages, however, may find that a significant amount of principal reduction during the 1,215-day prefiling period will be unprotected as deemed monthly acquisitions of homestead. Example two below illustrates how a bankruptcy court might make its calculations.
While many states are currently experiencing a decline in home appreciation, many homeowners have already benefited from significant appreciation in recent years. The Rasmussen decision that mere appreciation is not considered an interest acquired for purposes of calculating the $125,000 cap could enable homeowners to exempt considerably more than $125,000 of homestead value. However, if the language in footnote five of the decision is followed, principal amortization from regular monthly mortgage payments during the 1,215-day prefiling period would be included in the $125,000 cap, effectively reducing the exemption. For example, a $500,000 Florida homestead acquired with $100,000 down payment 1,200 days before a bankruptcy proceeding that appreciates to $900,000 at the time of the bankruptcy would be fully protected as long as principal amortization on the mortgage within the 1,215-day prefiling period was $25,000 or less as is necessary to come within the $125,000 cap.
Are Exempt Assets Converted Into a New Homestead Protected if Property was Purchased Within 1,215 Days of Bankruptcy?
The court’s conclusions in Rasmussen create a potential trap for those who use exempt assets (such as assets protected by Florida’s exemption for the cash value of life insurance insuring and owned by the debtor) to acquire or create equity in a homestead. As the court states in its opinion, “[T]he only exception to the $125,000 cap is for money derived and rolled over from the sale of a prior homestead within the state of Florida.”10 The Rasmussen court therefore asserted that homestead value acquired by the debtor from money attributable to exempt assets, other than a prior homestead, is not exempt.
Although the discussion in Rasmussen as to conversion of exempt assets to homestead was dicta, potential debtors should think long and hard before investing exempt assets in a homestead if the result of investment would cause equity in the homestead to exceed what would be protected within the 1,215-day prefiling period. Generally, the conversion of one form of an exempt asset into another will not jeopardize the creditor exempt status of the new asset.11 However, if the court’s reasoning in Rasmussen is followed in future litigation, the general rule protecting conversion of one exempt asset into a Florida homestead would not apply to assets converted within the 1,215-day prefiling period. Accordingly, while an investment of exempt assets will be protected 1,215 days after the assets are converted, the formerly exempt assets are subject to creditor’s claims until then, and the conversion results in the loss of a potentially important exemption during the 1,215-day prefiling period.
Therefore, when contemplating an investment in homestead equity, one should consider the benefits (arising after the exemption of the 1,215 period) and drawbacks (if, after converting exempt assets into homestead, one declares bankruptcy within 1,215 days) of converting exempt assets into homestead. Anyone contemplating such an investment decision must take into account the benefits of the potential exemption of appreciation on a homestead as described in Rasmussen above.
Effect of the Rasmussen Decision
While the dicta in the Rasmussen decision regarding the conversion of exempt assets into homestead may have potential drawbacks for debtors, the court’s protection of appreciation is critical for homeowners wishing to fully exempt their homesteads. The following examples describe the vast benefits and potential drawbacks flowing from the Rasmussen decision.
Example One: Equity Protected in the Homestead
Debtor, an unmarried physician, purchases a Florida homestead 1,200 days before he declares bankruptcy as a result of a medical malpractice incident that occurred six months after he moved into his home. The house was purchased for $1 million. To purchase the home, the physician withdrew $125,000 from his CD account, titled solely in his name, used $75,000 from the proceeds of the sale of his prior Florida homestead, and obtained an $800,000 interest-only mortgage. One year later, the physician withdrew another $100,000 from his CD account and prepaid a portion of his $800,000 mortgage, leaving a balance of $700,000. Because the physician’s mortgage was an interest-only loan, no amortization of principal occurred.
The bankruptcy trustee arranged for an appraisal of the home. The appraisal reflected that the home had appreciated to $1.5 million since it was acquired. As a result, the physician had $800,000 of equity in the residence at the time of the bankruptcy filing.
Based upon the court’s reasoning in Rasmussen, $100,000 would be available to pay debtors (attributable to the mortgage pay down within the 1,215-day prefiling period). According to Rasmussen, the $500,000 attributable to appreciation would be excluded because the phrase “acquired by the debtor” requires more than passive market appreciation; it requires, instead, an active acquisition of equity, such as an affirmative action of a down payment or mortgage pay down. Thus, the “amount of interest acquired by a debtor” would include: the 1) $125,000 down payment on the residence; and 2) $100,000 pay down of the mortgage. One hundred, twenty-five thousand dollars of this amount, however, would be excluded based upon the $125,000 cap in BAPCPA §521(p), leaving $100,000 subject to creditor’s claims. Additionally, the $75,000 that was rolled over from the physician’s previous homestead within the same state would also be excluded, leaving $700,000 in equity that would remain protected, as shown in the table.
Note that if a court were to follow dicta in the Rasmussen opinion, even if the $100,000 mortgage pay down or the $125,000 down payment had come from an exempt asset, such as the cash surrender value of a life insurance policy owned by and insuring the physician, the $100,000 over the statutory cap would still be subject to the claims of the physician’s creditors. According to Rasmussen, only exempt assets from prior homesteads within the same state will be protected within the 1,215-day prefiling period.
Example Two: The Effect of Principal Amortization during the 1,215-day Prefiling Period
Debtor, the same physician from example one, purchases a Florida homestead using the same funds as in the previous example; this time, however, instead of an interest-only mortgage the debtor chooses a traditional 30-year mortgage. During the 1,200 pre-filing days, the physician makes regular monthly payments that include approximately $31,500 in amortized principal payments. According to Rasmussen, this $31,500 would be considered an “interest acquired by the debtor” during the 1,215-day prefiling period and, therefore, included in the computation of the $125,000 statutory cap. If the court’s reasoning in Rasmussen is followed by other bankruptcy courts, $131,500, instead of $100,000 as in the previous example, would be subject to the physician’s creditors. The Rasmussen opinion assumes that the amount of principal amortization is likely to be insignificant in most cases. However, as this example shows, it can affect the total amount that can be invested into homestead before reaching the statutory cap.
The consequences are even greater for persons who have 15-year mortgages. If we assume the physician had a 15-year mortgage instead of the 30-year mortgage, the total amortization of principal within the 1,200 days could reach approximately $108,500, significantly lowering the additional amount the physician could invest in the homestead before reaching the statutory cap. If the physician wanted to keep as much as possible exempt from creditors under the homestead exemption, he could only invest $16,500 in additional funds (other than those rolled over from a previous homestead within the same state). Using the same investment figures, however, the physician would now have a total of $208,500 subject to the claims of creditors [$125,000 (from the down payment on the mortgage) + $100,000 (from the mortgage pay down) + $108,500 (from principal amortization) – $125,000 statutory cap].
Example Three: Tenants by the Entirety Protection v. Homestead Protection
While the previous example demonstrates the potential drawbacks of the court’s reasoning in Rasmussen, where principal amortization occurs during the 1,215-day prefiling period, homestead protection could significantly exceed the protection provided by tenants by the entirety ownership of nonhomestead assets (e.g., stock, bond, and cash accounts).
For example, assume the physician in example two was married and that he and his wife owned $1 million of marketable securities as tenants by the entirety as of January 1, 2007. Assume further that over the next three years the marketable securities increase in value by $500,000. In 2010, the wife unexpectedly dies. As a result, the physician is left with $1.5 million of unprotected marketable securities because they are no longer held as tenants by the entirety.
On the other hand, if the physician and his wife had invested the $1 million in a homestead, then, during both of their lifetimes, the home would be fully exempt from creditors if the judgment was against the husband or wife, but not against both of them, based upon the usual protection afforded by a tenancy by the entirety. In the event of a joint judgment against the husband and wife, $250,000 would be protected based upon Rasmussen if a bankruptcy proceeding occurred within the 1,215-day prefiling period (the husband and wife each would be able to protect $125,000 of their homestead). In addition, the $500,000 of appreciation would be protected even if there was joint debt.
Compared to maintaining the marketable securities in tenants by the entirety account, purchasing a new homestead (even if a bankruptcy is filed within 1,215 days of the purchase) would result in additional asset protection of $750,000 ($250,000 of exemption through the $125,000 per spouse “stacking” rule, plus $500,000 of appreciation). Furthermore, if the entire marketable securities account was used to purchase the homestead titled by the husband and wife as tenants by the entirety, it would provide an additional hedge in a bankruptcy proceeding that is not filed until after the 1,215-day period. If the wife’s death occurs thereafter, the homestead retained by the physician would benefit from the unlimited homestead exemption. If the funds were maintained in the tenancy by entirety marketable securities account, upon the death of the wife, the physician’s interest in the marketable securities account would be totally unprotected.
Conclusion
Rasmussen provides a roadmap for those who are investing in a new Florida homestead. A potential homeowner wanting to maximize the creditor-exempt status of his or her homestead should consider the following:
• Be cautious investing already exempt assets (other than proceeds from the sale of a prior homestead within the same state) into homestead beyond the $125,000 exemption ($250,000 for a husband and wife). These types of investments could subject previously protected assets to creditors’ claims.
• Investing a maximum of $125,000 ($250,000 for husband and wife) and equity from the prior homestead in the same state will provide full homestead protection and permit homeowners to retain any appreciation regardless of when the homestead was acquired or how great the appreciation during the 1,215-day prefiling period. Any homestead investment in excess of $125,000 ($250,000 for husband and wife) during the 1,215-day prefiling period is not protected by the homestead exemption based upon Rasmussen. The homestead investment includes down payments to acquire the residence together with mortgage amortization and principal prepayments (but not mere appreciation) during the 1,215-day prefiling period.
• State law must be reviewed to determine whether the above items would be applicable outside of the state of Florida. q
1 In re McNabb, 326 B.R. 785 (Bankr. D. Ariz. 2005) (ruling that BAPCPA §522(p) did not apply to residents of states that have chosen to opt out of the federal exemptions).
2 In re Buonopane, 344 B.R. 675 (Bankr. M.D. Fla. 2006); In re Landahl, 338 B.R. 920 (Bankr. M.D. Fla. 2006); In re Wayrynen, 332 B.R. 479 (Bankr. S.D. Fla. 2005); In re Kaplan, 331 B.R. 483 (Bankr. S.D. Fla. 2005).
3 BAPCPA §522(p)(1).
4 This issue was addressed in dicta where the court stated “The only exception to the $125,000 cap is for money derived and rolled over from the sale of a prior homestead within the [s]tate of Florida. Thus, homestead value acquired by the debtor from money derived from the sale of other exempt assets, other than a prior homestead, is also not exempt.” (Emphasis added.) Rasmussen, 2006 Bankr. LEXIS 2176 at 10. See discussion below addressing planning traps if other courts follow this proposition.
5 Rasmussen, 2006 Bankr. LEXIS 2176 (citing BAPCA §522(p)(1)).
6 In re Sainlar, 344 B.R. 669 (Bankr. M.D. Fla. 2006); In re Blair, 334 B.R. 314 (Bankr. N.D. Tex. 2005).
7 Rasmussen, 2006 Bankr. LEXIS 2176 at 25.
8 Id.
9 Id. at n. 5.
10 Id. at 10 (emphasis added).
11 In re Goldberg, 229 B.R. 877, 882 (Bankr. S.D. Fla. 1998)(stating that “The [d]ebtor…could not have formulated the fraudulent intent necessary to commit a fraudulent transfer if the source of the transfer is an exempt asset…because the source of the proceeds was exempt property, the proceeds [are] out of the reach of creditors as a matter of law.” See also Sneed v. Davis, 135 Fla. 271, 277-78 (1938) (stating “Creditors have no right to complain of dealings in property which the law does not allow them to apply to their claims, even though such dealings are with a purpose to hinder, delay, or defraud them.”
Barry A. Nelson is founder of the law offices of Nelson & Levine, P. A., and The Victory School for Children with Autism, both in North Miami Beach. He is Florida Bar board certified in both taxation and wills, trusts, and estates. Mr. Nelson is also an adjunct professor at the University of Miami School of Law Graduate Tax Program, and member of the American College of Trusts and Estates Counsel. He received his LL.M. and J.D., cum laude, from the University of Miami School of Law. The author acknowledges the significant contribution of Jennifer E. Okcular in preparation of this article.
This column is submitted on behalf of the Real Property, Probate and Trust Law Section, Rohan Kelley, chair, and Richard R. Gans and William P. Sklar, editors.
