Homestead Funds Still Part of Bankruptcy Estate Under Texas Law - U.S. Fifth Circuit
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Homestead Funds Still Part of Bankruptcy Estate Under Texas Law

Homestead exceptions are a nice public policy "plus" of bankruptcy law. They attempt to ensure that those filing for bankruptcy will have somewhere to go and lick their financial wounds after the case is finished.

But can the proceeds from selling your home be protected permanently from bankruptcy? The Fifth Circuit says no.

Texas Law Gives 6-Month Sale Exemption

Bankruptcy law is a strange hybrid of federal and state laws, and in this case Texas' law prevailed.

In Viegelahn v. Frost, Mark Alan Frost had filed for bankruptcy and then sold his homestead in a small town outside San Antonio. Frost argued that the homestead exemption protected that money from being assumed by the bankruptcy estate.

The relevant homestead exemption exists under Texas Property Code § 41.001, and permanently exempts homesteads -- but not the proceeds of their sales. The Texas law gives homestead sellers like Frost six months from the date of sale to reinvest the proceeds, or else they become subject to seizure.

Frost argued that the court should ignore the Texas distinction, and that once his homestead was exempt, any proceeds should be as well.

This isn't just a Texas-specific issue. Other states (see California) have similar timed exemptions for the sale proceeds of homesteads, usually giving the claimant six months to either reinvest or let the money be seized.

Exemptions Not Frozen in Time

The Fifth Circuit actually dealt with this issue before in In re Zibman, where a couple sold their home prior to filing bankruptcy but sought to protect the proceeds past the six-month period under the homestead exemption. The Zibman court found that the proceeds were not exempted after six months, but Frost points out that his timing was different.

Frost filed first, then sold his home. Under 11 USC § 522, Frost argues that his exemptions should be held in stasis from the start of his bankruptcy case -- no matter what form they take. As a law professor once told yours truly, this was more clever than correct.

The "snapshot rule" does keep exemptions fixed from the beginning of the bankruptcy filing, but fundamentally altering the character of the asset will make it ineligible for exemption. Texas' homestead exemption exempts the entire home (not merely an equity interest) from bankruptcy, but also provides that once sold, the exemption changes.

The Viegelahn court found that Frost had changed his interest in the homestead by selling it, and that the federal "snapshot" rule does not "prevent exempt property from losing its exempt status."

Bottom Line

Homestead exemptions are subject to expiry if you sell a home, either before or after filing for bankruptcy. After all, as Luther Vandross put it so well, a house is not a home if you sell it.

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