What Is the Homestead Exemption – Definition, Tax & Legal Treatment
Actually living off the grid is rare, but millions of American homeowners can truly call themselves homesteaders. That’s because the Federal Government – and most state governments too – extend special legal protections to homeowners’ primary residences.
Generally known as “homestead exemptions” (and the properties they protect generally known as “homesteads,” or “homesteaded properties”), these statutes exist to protect owner-occupants from excessive taxation, provide shelter for surviving spouses after their partners pass on, and shield some or all homestead equity from certain types of creditors. The federal homestead exemption applies specifically to homeowners filing bankruptcy. State homestead exemptions tend to be broader, with provisions that shield homeowners from some property taxes and, following death, provide their surviving spouses and dependents with protections against unsecured creditors and other claimants trying to seize their primary residence.
Homestead exemptions generally apply to detached and single-family homes, condominiums, and manufactured homes on land owned or leased by the homeowner. They do not apply to rental properties, vacation homes, and other residential properties that do not qualify as primary residences.
Provided they own the properties in question, individuals who can prove that they act as heads of household for properties whose residents qualify as their dependents can declare those properties as homesteads, regardless of where they actually live. For instance, if you’re a single, unmarried individual who rents your primary residence, owns your elderly parents’ home across town, and takes full financial responsibility for them (including paying the mortgage and making necessary repairs), you can likely claim it as a homestead. However, in all cases, a single head of household or married couple can only have one homestead, even if they own or act as heads of households for multiple residences.
Under Section 522(d)(1) of the U.S. Bankruptcy Code, homeowners can exempt a portion of the ownership interest (equity) in their primary residences from unsecured creditors (such as credit card issuers) whose loans aren’t secured by borrowers’ property.
As of 2016, the dollar value of the exempt property interest is capped at $23,675 for single individuals and heads of household filing bankruptcy, and $47,350 for married couples filing bankruptcy jointly. This is the amount that they’re owed if the property is seized and sold to satisfy outstanding debts. It rises every three years to keep pace with inflation.
Many states also have homestead exemptions that protect homeowners facing bankruptcy. The amounts of these exemptions can be higher or lower than the federal exemption. Homeowners are generally permitted by state law to choose between the state or federal exemption.
In states where the state exemption is more generous, it makes sense for homeowners facing bankruptcy to use it. The following states are examples:
If the value of your home is less than the value of the pertinent state or federal homestead exemption, it can’t be sold off to satisfy your creditors in bankruptcy.
In the more likely event that your home exceeds the value of the homestead exemption, it can be sold in bankruptcy. However, your creditors don’t get the full proceeds. You (or you and your spouse, if you’re married) get to keep a lump sum equal to the value of the individual or joint homestead exemption. You can use this sum as you see fit, including as a down payment on a new home or as a security deposit on an apartment.
Under federal law, the homestead exemption is part of a larger package of bankruptcy exemptions that protect physical possessions and entitlements from unsecured creditors:
Importantly, the homestead exemption does not protect your primary residence against foreclosure. If you become delinquent on your mortgage, you can’t remain in your house simply because it’s your homestead.
The homestead exemption also may not apply against other loans or debts secured by your interest in your home, such as mechanics’ liens and FHA renovation loans. If you’re unsure whether a specific type of debt is covered, check with a real estate attorney licensed to practice in your area.
If your state does not have its own homestead exemption, you can take advantage of the federal homestead exemption during a bankruptcy filing. However, most states with homestead exemptions (though not all) are more generous than the federal exemption.
That’s the case in Massachusetts, where the homestead exemption ranges up to $500,000, per the Norfolk County Registry of Deeds. In other cases, the state exemption does not specify a dollar limit. Instead, it applies to a specific acreage, so its generosity depends on the value of the underlying property. For instance, Iowa lets homeowners protect their entire homestead interest, subject to an acreage limit of 0.5 acre in incorporated cities and towns, and 40 acres in rural areas and unincorporated communities.
Some states with homestead exemptions opt out of the federal system. If your home state is one, you have to use the local homestead exemption. If your home state lets you choose between the state and federal exemption, you can do so – probably by choosing the more generous of the two.
Exemption Limits Under the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act
The federal Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), passed in 2005, imposes some important limitations on state homestead exemptions in bankruptcy.
The most important is the closing of the so-called “mansion loophole,” through which heavily indebted individuals established residency in states with favorable homestead laws, parked their available cash in homestead real estate, and declared bankruptcy shortly thereafter. This frequently occurred in Florida, which had a lenient, acreage-based homestead exemption.
BAPCPA capped the state homestead exemption at approximately $155,000 for individuals and approximately $310,000 for married couples in the following instances:
Like the standard federal homestead exemption, the BAPCPA exemption rises periodically to keep pace with inflation. It applies in all 50 states, and supersedes state law whenever a conflict arises.
Whereas the federal homestead exemption is designed specifically to protect homeowners against unsecured creditors in bankruptcy, state homestead laws are broader. They generally protect individual heads of household, married couples, and sometimes single individuals (including dependents and non-dependents).
They focus on three important areas:
State homestead laws often shield homeowners insurance proceeds from creditors for a set period of time (usually one to two years, but potentially longer) after a covered event that severely damages or destroys a homesteaded property.
Homestead statutes do not give homeowners carte blanche to stiff creditors or local tax authorities. Some state statutes are more generous than others, but none are absolute.
In addition to mortgages and other liens secured by interest in the homesteaded property, homestead laws tend not to protect homeowners and their heirs from:
Additionally, homesteaders must understand their state statutes’ requirements for homestead maintenance. For instance, in some jurisdictions, even temporarily renting out a homesteaded property constitutes abandonment and can void the protections afforded by state statutes.
The following is a representative sample of state homestead statutes. Keep in mind that their content, especially dollar values, are subject to change as new laws are enacted. For up-to-date information about homestead laws in your locale, check with your state legislature or housing authority.
The procedure for homesteading a primary residence varies by jurisdiction, but is generally neither difficult nor expensive. In most states, a residence earns homestead status simply by virtue of the homeowner closing on the property and declaring it his or her primary residence.
In Nevada, Virginia, and Vermont, a formal homesteading procedure is required. Even in states where formal homesteading is not required, the formal declaration of a homestead confers important protections, such as the continuation of the homestead designation and the protection of sale proceeds from creditors for a set period (which varies by state) after the home is sold.
In general, the homesteading process follows this outline. For instructions specific to your locale, check with your state or city housing authorities.
Though homeowners insurance and homestead law bear little resemblance to one another in a legal sense, they both protect against catastrophic losses that can change a family’s life overnight. Just as you’d like never to file a claim with your home insurer, you’d prefer never to test the limits of your state’s homestead exemption for bankruptcy filings or occupancy allowances for surviving spouses. But, when all is said and done, it’s comforting to know that at least some of your interest in your primary residence is partially protected from misfortune.
Do you live on a homesteaded property?
Brian Martucci writes about frugal living, entrepreneurship, and innovative ideas. When he’s not interviewing small business owners or investigating time- and money-saving strategies for Money Crashers readers, he’s probably out exploring a new trail or sampling a novel cuisine. Find him on Twitter @Brian_Martucci.
What Is the Homestead Exemption – Definition, Tax & Legal Treatment
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