Does Contract To Sell House Forfeit Homestead Exemption?

A caller this week was interested in filing bankruptcy but is concerned about preserving a valuable homestead owned free and clear. The caller stated that he had signed a contract to sell the house for about $500,000. He is concerned about protecting the house and sales proceeds in a Chapter 7 bankruptcy.

The sales contract provides that closing will be held after the seller files bankruptcy. The first question that comes to mind is whether the debtor can claim the property as exempt homestead if he has signed a contract to sell the house. There are a few cases which have held that signing a contract to sell does not constitute abandonment of the property as homestead. The courts stated that the property is the debtor’s homestead as long as it is the debtor’s primary residence on the date of filing.

Keep in mind that many sales fall through at the last minute because the buyer’s lender cancels financing or because a change in the buyer’s circumstances violates financing conditions. This seller has not sold his homestead until the check clears after closing regardless of provisions of a sales contract. Also, there is no place on the bankruptcy petition where the debtor obviously would list the contract to sell the house.

As a practical matter, a trustee with knowledge of the house sale contract. may still challenge the homestead exemption. The debtor would have to pay the trustee to settle the issue or pay legal fees to defend the exemption in bankruptcy court.

This caller asks whether he and the buyer should agree to rescind the house sale contract and enter into a new contract after the seller files Chapter 7 bankruptcy. That would remove the homestead exemption issue, but the buyer would also be free to find another house or to renegotiate the price in the second contract.

I suggested that the seller proceed with the bankruptcy petition and vigorously defend the homestead exemption if challenged.

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