READJUSTING DEBT AND WRITING CONTRACTS

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Keep in mind, however, that debts are not discharged unless they are "old," remaining unpaid for a tax return filed more than three years before the bankruptcy filing. Similarly, certain student loans will not be discharged unless the first payment on the loan was due more than seven years prior to the bankruptcy filing.

A third category of debts that will not be discharged are alimony and support payments. The property aspects of a divorce settlement may be discharged, but the alimony and support aspects may not be discharged. A fourth category of debts are those that are fraudulent. An example of fraud may include a material misrepresentation on a loan application—overstating one's income or assets, for instance.

Equity and Exemption

In many circumstances debtors can file a bankruptcy petition and be able to keep their house, household goods and furnishings, an automobile, and the tools of their trade, making a fresh start in life that much easier. Exactly which items a debtor may keep is determined by a combination of federal and state laws referred to as the "exemption" laws. The generally understood theory about bankruptcy is that a debtor must "liquidate," or sell all possessions and distribute the proceeds of the sale to creditors. But the federal bankruptcy laws exempt various types of property from the liquidation process, so long as the property does not exceed a certain value.

A FRESH START Bankruptcy allows people with more debt than they can presently repay to take charge of their lives—to be productive again.

Believe it or not, the tax laws in bankruptcy also help a debtor keep his house. If the trustee sells the house, the trustee must pay the federal income taxes resulting from the sale. In our example, if the house had been purchased by a couple 20 years ago for a mere $50,000 and sold this year for $150,000, the taxes on the capital gains of $100,000 (approximately 1/3 of that amount, or $33,000) would have to be paid by the trustee out of the sales proceeds. So the trustee will not force the sale of a debtor's house worth $150,000 unless the equity after payment of the mortgage is more than the combination of the debtor's exempt equity ($15,000), the transaction costs (estimated at 10 percent, or $15,000 in our example), and the capital gains tax ($33,000 in our example). In our example of a house with a fair market value of $150,000, the available equity would have to exceed $63,000 before the trustee forces a sale. Therefore, a debtor with a large mortgage may be able to keep his house, despite the filing of bankruptcy.

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