One question I frequently hear from prospective bankruptcy clients is: Can I sell my house before filing Chapter 7 bankruptcy?

The short answer is yes. You are absolutely permitted to sell your home before filing bankruptcy. In fact, there are situations where selling your home before filing Chapter 7 may make perfectly good sense.

However, there is one very important thing you need to understand: If you receive money from the sale of your home, you need to keep a very accurate accounting of exactly how that money is spent before you file bankruptcy.

Let me explain why this is so important.

What Happens If You Sell Your House Before Filing Bankruptcy?

When you sell a home, you will receive a closing package containing numerous documents. One of the most important documents is the settlement statement, which shows the financial details of the transaction.

The Chapter 7 bankruptcy trustee will want to see a copy of your closing package. In particular, the trustee will focus on the line on the settlement statement showing the amount due to the seller at closing.

This is an important number.

If the settlement statement shows that you received $10,000, $20,000, or some other substantial amount of money from the sale, the trustee is going to want to know what happened to that money.

Where did it go?

How was it spent?

Was it deposited into a bank account? Were bills paid? Were large purchases made? Were any family members or friends paid?

The trustee is not simply interested in the fact that you sold your house. The trustee wants to determine whether the proceeds were properly spent or whether money was transferred to someone in a manner that could create a problem for your bankruptcy case.

Be Careful About Paying Family Members, Friends, or Business Partners

This is where I see people potentially get into trouble.

Chapter 7 trustees routinely examine financial transactions that occurred before bankruptcy was filed. They are particularly interested in payments or transfers made to what are commonly referred to as insiders.

Insiders can include:

• Parents, children, siblings, and other close relatives.
• Close personal friends in certain circumstances.
• Business partners.
• Other individuals or entities with a close relationship to the debtor.

For example, suppose you sell your home and receive $25,000 at closing. You owe your brother $8,000 from a personal loan he made to you several years ago. You decide to pay him back with some of the money from the closing.

That might seem like the right thing to do. After all, you owe him the money.

However, paying back a family member shortly before filing bankruptcy can create a preference issue under Section 547 of the Bankruptcy Code. A payment to an insider may be subject to a longer preference lookback period, generally one year before filing, compared with 90 days for most other creditors. Whether a payment can actually be recovered depends on the circumstances and the statutory requirements.

The same concerns can arise when paying back business partners or other individuals who qualify as insiders.

There can also be fraudulent-transfer concerns under Section 548 of the Bankruptcy Code, particularly if you give money away or transfer property to someone else for less than reasonably equivalent value while meeting the applicable financial conditions.

For example, giving $5,000 to a relative or close friend just before filing bankruptcy is not necessarily a way to protect that money. The trustee may have the ability to challenge that transfer.

My advice is simple: Do not use the proceeds from your home sale to pay off relatives, friends, or business associates without first discussing the transaction with your bankruptcy attorney.

Can I Protect the Money I Receive From Selling My House?

Possibly. This is where bankruptcy exemptions become extremely important.

Under federal bankruptcy law, there are exemptions that may allow you to protect money received from the sale of your home, depending on the circumstances and the exemptions available to you.

One exemption that I frequently consider is the federal wildcard exemption under 11 U.S.C. § 522(d)(5).

The wildcard exemption can be used to protect certain property that is not otherwise covered by another exemption, subject to the applicable statutory limits and any available unused portion of the federal homestead exemption.

For example, I have represented clients who sold a property before filing bankruptcy and received approximately $10,000 at closing. After reviewing their circumstances and available exemptions, we were able to protect that money using the available federal wildcard exemption.

In that situation, the trustee could see the $10,000 on the settlement statement and verify that the money was accounted for in the client’s financial records.

There is an important distinction here, however. Just because money is fully exempt does not mean the trustee loses the ability to examine what happened to it before bankruptcy was filed. The trustee can still investigate payments to insiders, gifts, and other potentially avoidable transfers. An exemption protects qualifying property from creditors; it does not automatically protect improper transfers made before filing.

If the proceeds are fully exempt and have been properly retained or spent on legitimate expenses, there may be no nonexempt proceeds for the trustee to administer. That is a very different situation from transferring money to someone else in an effort to keep it away from creditors.

Of course, every case is different. The amount of the available wildcard exemption depends on the applicable statutory limits, the debtor’s other exemptions, and whether the debtor qualifies to use the federal exemption system in the first place. It is important to evaluate this before filing.

The Best Way to Keep Track of Your Home Sale Proceeds

If you sell your home before filing Chapter 7 and receive money at closing, I strongly recommend the following:

1. Deposit the closing check into your bank account. Avoid receiving cash or distributing the money to different people.
2. Keep the entire closing package. Your bankruptcy attorney and the Chapter 7 trustee will want to review the settlement statement and other closing documents.
3. Use your bank account to pay expenses. Pay bills by check or debit card so there is a clear record of where the money went.
4. Keep receipts and records. If you make a substantial purchase or pay an unusual expense, keep documentation explaining the transaction.
5. Do not pay relatives or close friends. Avoid paying off personal loans owed to family members, friends, or business partners shortly before filing without first obtaining legal advice.
6. Do not make large gifts. Transferring money to someone else does not make the money disappear for bankruptcy purposes.
7. Keep the money separate if possible. Maintaining a clear record of the sale proceeds and how they are spent makes it much easier to account for the money later.

The objective is to make it easy for the trustee to follow the money from the closing table to wherever it ultimately went.

A clean paper trail can make a substantial difference in how smoothly your bankruptcy case proceeds.

What If My House Is Underwater and I Cannot Sell It?

Another situation I am seeing increasingly often involves homeowners who have been trying unsuccessfully to sell their homes.

During the post-pandemic real estate boom, many homeowners saw substantial increases in their property values. However, the real estate market has cooled in portions of the Metro Detroit area, and I am now seeing prospective bankruptcy clients who are actually underwater on their homes.

In other words, they owe more on their mortgage than the property is worth.

They may have their home listed for sale, but even if they receive an acceptable offer, the mortgage payoff, real estate commissions, taxes, and other closing expenses leave them owing more than the sale proceeds.

They would actually have to bring money to the closing table just to sell their home.

In these situations, I generally want to examine several things:

• What is the current fair market value of the property?
• What is the outstanding mortgage balance?
• Have there been any actual offers on the property?
• How much would the homeowner have to bring to closing?
• Is there any equity that could be protected through applicable bankruptcy exemptions?

Sometimes, after reviewing the numbers, the best option is simply to file Chapter 7 bankruptcy and surrender the property.

Remember, you do not have to successfully sell your house before filing bankruptcy. In an appropriate case, you can surrender the property through the bankruptcy process and deal with the mortgage deficiency as part of your bankruptcy case.

I have represented many homeowners over the years, and this is an area where careful planning before filing can make a substantial difference.

The Bottom Line: Selling Your House Before Bankruptcy Is Permitted, But Plan Ahead

You absolutely can sell your house before filing Chapter 7 bankruptcy. There is nothing inherently improper about selling real estate before filing.

However, if you receive money at closing, you need to be prepared to account for it.

The Chapter 7 trustee will review your closing package, pay particular attention to the amount shown as due to the seller, and may ask you to explain what happened to those proceeds.

Do not give money away, pay off relatives, or make unusual financial transactions simply because you believe the money will no longer be available when you file bankruptcy.

There may be exemptions available to protect some or all of the money, including the federal wildcard exemption under Section 522(d)(5). But the exemption analysis needs to be done before you file, and remember that an exemption does not automatically shield pre-bankruptcy transfers from scrutiny.

My advice is to speak with an experienced bankruptcy attorney before selling your home if you are considering bankruptcy. A little advance planning can prevent unnecessary complications with the Chapter 7 trustee and help protect money that you may otherwise be entitled to keep.

I have practiced bankruptcy law exclusively for more than 35 years and have represented more than 25,000 people. I regularly work with homeowners facing difficult decisions about whether to sell, surrender, or otherwise deal with their homes before filing bankruptcy.

If you own a home, are having financial difficulties, and are considering Chapter 7 bankruptcy, I would be happy to review your circumstances and discuss your options.

Law Offices of Walter Metzen
313-962-4656
Detroit Bankruptcy Lawyer
www.detroitbankruptcylawyer.com