What happens to my house if I go bankrupt?

Article by Mark Davidson

Ever wondered what would happen to your property in bankruptcy and if it was possible to keep it? It depends on number of factors, however the key thing to understand is that your interest in a property upon becoming bankrupt vests in your trustee, on behalf of your creditors.

If your property is solely owned.

The property vests in your bankruptcy trustee. So if your property is worth $500,000 with no mortgage, then your trustee now has control of this. The trustee would request that you vacate the property and then they would proceed to sell the property on behalf of your creditors.

If the property is an investment, the trustee would allow the current tenants to stay until the end of the tenancy agreement and market and sell the property on behalf of your creditors. Prior to the property’s sale, the trustee would collect the rent.

Note: you could become liable for capital gains tax upon the sale of an investment property by your trustee, as any such debt is a post-bankruptcy debt which you owe.

If the property has a mortgage, then it still vests in the trustee, but from any sale the bank must be paid first. For example, if the house was valued at $500,000 and it had a mortgage of $400,000, then only $100,000 would be available to your trustee. Sometimes this can lead to opportunities where a friend or family member can purchase the equity component from the trustee.

Now, what if the property was actually worth $400,000 and the loan was $500,000 (e.g. negative equity)?

Your trustee is unlikely to sell the property without the bank’s approval, as there is no benefit to your creditors. Being bankrupt means that you will be in default of your mortgage and the bank will have the right to repossess and sell the property. If the bank does this, then the residual debt of $100,000 would be a debt of your bankrupt estate. The bank could make a claim for their debt through Lender’s Mortgage Insurance, if applicable. The insurer would then claim as a creditor in the bankrupt estate.

Interestingly, some lenders have allowed property owners to continue to live at the property, in default, providing that they are able to make the mortgage repayments. This can cause problems down the track as the trustee continues to have a claim against the property for up to 20 years.  Therefore even if your property has no equity it is still prudent to have someone make an offer to purchase it from your bankruptcy trustee for a nominal amount so that if down the track there is equity in the property your bankruptcy trustee cannot claim it.

In any transaction involving a family member or friend purchasing the property of a bankrupt, consideration also has to be given to when transfer duty (formerly stamp duty) would be payable, as the amount of transfer duty on any sale may be significant.

If the property is jointly owned.

If the co-owner is also bankrupt then the scenario is similar to above. Either it will be the one trustee that controls the two bankrupts’ interest or two trustees, representing creditors from the different estates.

If the co-owner is not bankrupt, then the trustee would usually request that the co-owner joins them in a sale or alternatively, purchases the bankrupt’s interest from them. Another party could also purchase the interest from the trustee and does not have to be the co-owner.

If the co-owner wishes to purchase the bankrupt’s interest, they need to provide a reasonable offer that would reflect a similar price if the property was sold. No discount or advantage would be applied because you are the co-owner. Trustees have a duty to act in the best interest of creditors.  Again in these circumstances consideration should be given to any transfer duty payable.

If the co-owner joins the trustee in the sale, they will agree as to how the proceeds will be split. This is where the doctrine of exoneration (i.e. where a bankrupt may have borrowed against a property for his or her own benefit this might reduce the bankrupt’s claim to the equity in the property) could help the co-owner’s claim for a larger portion, but it could work against them too, so it is best to seek legal advice.

If the co-owner and trustee cannot agree, usually there may be an application made to court to appoint a statutory trustee to sell the property on their behalf and distribute the proceeds accordingly. Note: this will usually be to the detriment of both parties as the statutory trustee will take their costs as priority from the sale.

What if you financially contributed to the property but are not in title?

The trustee can still claim against a property that a bankrupt has contributed to. The trustee would conduct an investigation to determine what the bankrupt has contributed to the property, including:

  1. Payments made to the mortgage;
  2. Contribution towards deposit;
  3. If the bankrupt resides in the property and whether they pay rent;
  4. Contribution to the maintenance and upkeep of the property; and
  5. The intention of the co-owner and the bankrupt regarding the property.

Potentially the trustee can claim for the amount the bankrupt has contributed to the property and any increase in value their contribution has caused.

What about household belongings?

You will normally be able to keep most everyday household items, however you need to disclose all items of value in your bankruptcy such as jewellery or rare collections. Your trustee can sell items of significant value or above a set amount.

What if I have transferred my property or sold it before going bankrupt? 

The trustee will review the sale and they have certain powers to take recovery action against the purchaser if the sale was for undervalue.

If the property was sold for market value, but you disposed of the proceeds, then the trustee may be able to recover those proceeds from the recipient. The trustee has special powers to clawback any transactions completed with the intention to avoid paying creditors.

Contact us for advice

It is best to seek professional advice, when you own property and have significant levels of debts, before making a decision to your detriment. If you require assistance, please don’t hesitate to get in contact with us for a no-obligation consultation.

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