We recently posted an article that got into the details of the different types of bankruptcy. Specifically, we wanted to help our readers understand the differences between Chapter 7 (“Straight Bankruptcy”) and Chapter 13 (“Reorganization”), the two most common forms of bankruptcy people file.

Shortly after we posted that article, a reader (let’s call her Jessica) got in touch with us with a common predicament: Jessica and her husband got divorced last year.Her husband left her with the house – and a mortgage payment she could not afford on her own. She had a ton of student loan debt, and to make things worst, Jessica ended up in the hospital with an acute medical condition. Not only did Jessica lose her job, but she racked up enormous medical bills in the process. After exploring her options, it seemed like filing for bankruptcy was her best way out. Jessica recently filed for Chapter 7 bankruptcy, and the proceedings are ongoing.

Jessica contacted us because she wanted to know: Can she sell her Texas home while in the middle of bankruptcy proceedings? And if so, will she be able to keep the money or will it go to her creditors?

The answer: it depends

We are not lawyers, but we tried to offer some insight she could use as she discussed her case with her attorney.

Texas Is A Strong Property Rights State

As you may recall from our last article on bankruptcy, Texas has some of the strongest homestead protections in the country. In Texas, the equity in your home is exempt from bankruptcy proceedings, meaning that it cannot be sold to your creditors to cover your debts.

This also means that a Texas homeowner can sell his/her home during bankruptcy proceedings (both Chapter 7 and Chapter 13), but the timing of the sale is critical. You should let your lawyer know as soon as possible that you want to sell your home, and discuss how to do so before putting your home on the market. The bankruptcy court where your case is filed may have special rules you need to follow, such as whether or not you are required to use a real estate agent.

The bankruptcy judge overseeing your case will also need to review the terms of the sale and grant you permission to move forward. It can take upwards of a month to get a hearing before the bankruptcy judge, so you’ll want to plan ahead and include language in your Purchase & Sale Agreement that the sale is subject to the court’s review. Otherwise, you might miss important real estate deadlines that put your transaction at risk.

Filing a “Motion to Sell Property”

Plan to call your lawyer as soon as you sign a Purchase & Sale Agreement. In Texas, your attorney is required to file a “Motion to Sell Property” with the bankruptcy court. The motion outlines the terms of the agreement and proposes how to disburse the proceeds from the sale. As noted above, your equity in the home is protected under Texas’s homestead law, but there may be additional funds generated by the sale in excess of your equity.

A quick example: You have $100,000 worth of equity in your home and a $250,000 mortgage left on the property. Your home has appreciated in value over the years, and you plan to sell it for $500,000. You will receive $100,000 from the sale proceeds; another $250,000 will be used to pay off the mortgage. The Motion to Sell Property will outline how to divide the remaining $150,000 from the sales proceeds.

Your attorney might petition the court to give you a portion of those proceeds for moving or to reinvest in another property. Ultimately, your court-appointed bankruptcy trustee will decide how to distribute the remaining funds and to whom. Depending on the details of your case, the trustee may feel other creditors should be repaid first.

The more time and information you give your attorney, the more time he/she will have to negotiate with the bankruptcy trustee overseeing your case.

When You Sell Matters Most

If you want to protect the equity in your home under Texas’s homestead exemption, the timing of when you sell your home matters most.

Filing for bankruptcy is a long, multi-step process. The tail end of that process includes the court issuing a bankruptcy discharge before the case is closed. A Chapter 7 bankruptcy discharge releases you from your legal obligation to repay the dischargeable debts you owed when your case was filed. (Under a Chapter 13 bankruptcy, debts are not discharged outright, but rather restructured.) After your bankruptcy discharge is filed, it can still take another 3-6 months for your case to be closed officially and a bankruptcy decree is filed.

Bankruptcy discharge vs. bankruptcy decree – the difference may seem like minor nuances. In reality, the differences between the two are critical to when you sell your home.

In March 2014, the Texas 5^th Circuit Court of Appeals ruled that if a debtor in bankruptcy sells a home claimed as exempt under Texas law, the proceeds from that sale are only exempt for six months unless all of the proceeds are reinvested in another Texas homestead.

In other words, if you sell your home after your bankruptcy discharge but before your bankruptcy degree, you only have six months (180 days) from the date you sell your home to reinvest that into another property. Any amount not used to purchase a new home during that period becomes non-exempt and must be turned over to the bankruptcy trustee for distribution to your creditors. It may seem easy enough to buy another home within six months, but anyone familiar with real estate knows that buying and selling can sometimes be unpredictable – what seemed like a straightforward deal can become complicated, delayed, or fall through altogether for any number of reasons.

An alternative solution is to wait to sell your home until after your case officially closes and the bankruptcy decree is filed. This way, you do not have to reinvest sales proceeds into another home. You can spend that money however you want.

Thankfully, for Jessica and others, Texas law provides tremendous protections for homeowners facing bankruptcy. As outlined above, it is perfectly legal to sell your home during bankruptcy proceedings – but there are some reasons why you may not want to. It really depends on your long-term plans, and whether you anticipate buying another home right away or not. We suggest speaking with a Texas bankruptcy attorney to explore your options.