Investing in real estate is a time-honored way to build wealth. Real estate performs better over time than almost any other asset class, whether we’re talking about stocks or something newer and flashier like cryptocurrency. Plus, it doesn’t carry the same level of risk that other investment vehicles do – land will still be there in 20 years, but will the company issuing the stock still be around? It’s a gamble.

Of course, there are threats that exist. One of those is the specter of bankruptcy. What happens to investment real estate during bankruptcy? Is there a way to safeguard your investments (and the wealth they represent)?

Yes, there are ways that you can prevent your investment properties from being sold in some cases. In this post, we’ll explore what you need to know about investment real estate and the bankruptcy process.

 

The US Bankruptcy Situation

According to the US federal government, 2020 marked a record year for bankruptcies in the US, but probably not the way you assume. In fact, bankruptcy filings fell by almost 30% for the 12 months ending December 31, 2020. Only 544,463 consumers and businesses filed bankruptcy in 2020, compared to almost 775,000 in 2019. This decline was seen across both Chapter 7 and Chapter 13, although Chapter 11 (reorganizations) saw an increase of almost 19%.

However, while that decline is good news for the US as a whole, it is not the entire picture. Millions of Americans still struggle with debt, and it’s all too easy to find yourself facing the prospect of bankruptcy. If that sounds familiar and you have investment properties, you will need to choose your path with care. Your first step toward relief is to choose the right type of bankruptcy.

 

Determine the Right Type of Bankruptcy in Georgia

First, understand that real estate investments are treated differently under Chapter 7 and Chapter 13 bankruptcies. In Chapter 7, your assets are liquidated to pay your creditors, but in Chapter 13, you come up with a repayment plan and all of your properties are protected. Of course, you might need the benefit of Chapter 7 instead of the restructuring offered by Chapter 13.

Does this mean that you’ll have to give up your real estate investments? Maybe not. There are several key things you should know about both of your bankruptcy options and how they affect investment real estate.

 

Chapter 7

Chapter 7 is what most people think of when they imagine filing bankrupt. In this situation, most of your debts (if not all) are forgiven. However, to do that, most of your assets will be taken and sold, and the proceeds of those sales will go to pay your creditors in the order of priority determined by the court. Only those assets that are excluded, such as your primary residence, will not be sold.

For many people, filing Chapter 7 is the only way to start over – to wipe the slate clean and get a second try at building a stable financial life. Does that mean that your investment properties will be sold during this process?

Chances are good that they will, but there are a couple of possible ways to protect them.

1. You can exempt them from the process: Most states have some sort of exclusion for real estate. This usually applies to your primary residence (the homestead exemption). However, homestead exemptions are not allowed for rental properties, so you may need to apply for a wildcard exemption if one is available. Each state has its own list of exemptions and they can vary wildly from one another.
2. You have little or no equity in the property: The entire point of the trustee taking and selling property is to satisfy creditors (and the more creditors that can be satisfied, the better). If you currently have little or no equity in the investment property, there is little reason for the trustee to sell it, as it would do no good in terms of paying your creditors. In these instances, you may be able to keep the property.

 

A Caveat

During the Chapter 7 process, you’re able to decide how to handle secured debts. For instance, if you want to keep your investment property rather than surrender it, you could reaffirm your loan or tell the judge that you want to continue making payments. However, this does not necessarily safeguard your real estate. It is still possible for the trustee to take it and sell it if in so doing, they can raise significant money to pay your creditors.

The converse is also true here, though. For instance, if you’re currently underwater on the investment property (you owe more than it is worth), you could choose to surrender it to the lienholder. This automatically settles your entire debt with them even if you technically owe more than what the property is worth. Your bankruptcy will wipe out any portion beyond the value of the property.

So, in nutshell, Chapter 7 may not be the best option for those hoping to protect their investment properties during bankruptcy. However, if your state has the right exemptions, or you have very little or no equity in the property and require the other benefits offered by this type of bankruptcy, it might be worth considering.

 

Chapter 13

Chapter 13 differs significantly from Chapter 7 in many key ways. For instance, this option allows you to keep your investment property. Instead of liquidating your assets to pay off creditors and then wiping your slate clean, this option allows you to create a repayment plan and then pay down your debts over time.

With that being said, it’s not necessarily a simple, direct process and there are several impacts to your real estate investments that you’ll need to be aware of here.

 

Cramdowns

In certain situations, you can “cramdown” your mortgage. This can work to your advantage by reducing your debt load while you maintain ownership of the investment property. For instance, if you owed $150,000 on an investment property, but it was only worth $75,000, you could petition the judge to cramdown your mortgage to the current value of the property. Note that this cannot be used with your primary residence (which is protected by an exemption) and only applies to investment properties.

There is a catch with cramdowns, though. While it will help you reduce the amount that you owe, you’re required to repay the entire amount during the repayment period of your bankruptcy, which will last just three to five years. For most people, cramdowns are off the table simply because it’s incredibly difficult to come up with such a large sum of money in so short a time, particularly when you’re already financially stressed and still paying down your other debts.

 

Your Payments May Increase

There’s a rule embedded into every Chapter 13 bankruptcy that says you must repay all unsecured creditors at least the value of your nonexempt property. That includes your real estate investments. In other words, these creditors are legally guaranteed at least as much money in a Chapter 13 bankruptcy as they would see if you filed Chapter 7, instead. If you have a lot of equity built up in those investments, there’s a very good chance that your plan payments will be higher than they would otherwise.

However, if you don’t have much in the way of equity, or you have no equity at all, then it may not have any impact on your payments. If the equity in your investments is protected, you may not see much of an increase in your payments, either.

 

Arrearages

Missed payments lead to foreclosure. If you’ve missed a few payments on your investment property, Chapter 13 provides you with protection against foreclosure, allowing you to roll your arrears into your repayment plan. You’ll have three to five years to pay those off.

As long as you’re able to make the current payment, plus your repayment agreement, you can skip the foreclosure process. It also ensures that you’re not on the hook for repaying all those missed payments in a single lump sum.

 

Negative Cash Flow

What if your investment property isn’t generating any income? If you have negative cash flow, even Chapter 13 might not be enough to protect your investments. The trustee will argue that your case should be dismissed unless the property is surrendered to the lienholder. If you have negative cash flow, chances are good that the judge will agree.

To get around this, you need to opt for what’s called a 100% plan. In this situation, you pay back all of your unsecured creditors in full. So, there’s very little debt reduction to be had, but you can restructure things so that you have some breathing room while making sure that your creditors get what they’re owed. If you can create this sort of plan and still pay for your investment properties, the judge will likely allow you to keep your properties.

 

Alternatives to Bankruptcy in Georgia

While bankruptcy may seem inevitable, the truth is that there are alternatives out there. For instance, you can contact your creditors and attempt to arrange a payment plan with them on your own. You can also work with a credit counseling agency to manage your debt. If some of the debts are erroneous or you think you should not owe them, you can also dispute them in court.

Finally, you can work with an attorney to create a debt settlement plan that will satisfy your creditors, while costing you less than filing for bankruptcy or working with a credit counseling agency. This final option also allows you to avoid the black mark a bankruptcy leaves on your credit report.

 

Finding Your Path Forward

Navigating the world of bankruptcy while protecting your investment real estate can be challenging. Working with a bankruptcy attorney ensures that you have the information you need about your options and can find the right path forward.