Can you shelter your home from bankruptcy?

Q: I have a friend who is thinking about filing for bankruptcy. He currently has a property that he owns and wants to change the ownership title to a relative before he files for bankruptcy. But I’m worried that his relative will get penalized because they’ll see through his plan. Is that the case? Or can he effectively shelter his property from the bankruptcy proceedings?

— Shelter from the storm, Calgary, Alta.

Answer from Walter Melanson, lead analyst at PropertyGuys.com:

The beauty about PropertyGuys.com is that we have experts in all fields, including highly experienced real estate lawyers, including Stuart Murray, from Mullin Law.

But in order to understand how bankruptcy impacts your home ownership, we must first understand what a bankruptcy is under Canadian law. In simple terms, a personal bankruptcy is a legal process where the assets of the estate (the estate is everything you legally own) are distributed among the people, institutions and businesses you owe money to. The person responsible for making this happen is the bankruptcy trustee—a person appointed to administer the estate.

To do all of this, a bankruptcy trustee is required to “investigate an individual’s affairs.” For instance, when a person files for bankruptcy in Ontario, the trustee will ask him or her a number of questions, including “in the last five years did you sell any property?” This question is important to the trustee because a large part of what they have to do is to determine what property an individual has and what can be sold off to collect funds for his or her creditors.

The trustee will also ask about any property that an individual had shortly before filing, and what happened to it. If property was sold off, an individual will be expected to account for the money received and where that money ended up.

If an individual sold his or her house and moved the money—say, to an offshore account—he or she would be required to repay the money to the trustee before he or she would be discharged (be given bankruptcy status, and all the protection from creditors that this provides).

Now, before you think you can hide the sale of a house, consider the fact that all real estate transactions are now easily traceable—all house sales, even private sales, are recorded electronically and are easily searchable. Also, lying about this type of transaction is a criminal offence (the maximum penalty is a jail sentence). Even transferring a property out of your name into someone else’s name cannot protect the property from the bankruptcy process, as the courts consider a transfer a “deemed disposition”—in other words, the property was as good as sold, and even if no money changes hands, the theoretical sale price will be determined based on the fair market value of the home. The proceeds of this “deemed disposition” sale would then need to be turned over to the bankruptcy trustee and the proceeds distributed to your creditors.

The way the transfer is treated under a bankruptcy depends on the answers to three questions:
1) Did you intend to commit fraud?
2) Did you sell or transfer the property for less than its fair market value?
3) When did the transfer occur?

How these questions are answered will dictate what actions are taken, both within the bankruptcy and within the justice system (if necessary). Remember, bankruptcy is a very serious matter. It’s best to explore all options for dealing with debt prior to choosing bankruptcy, including negotiating a settlement with the creditors, getting a debt consolidation loan, doing a debt management plan through a not-for-profit credit counsellor, or filing a consumer proposal.

Long story short, it’s not worth it to try any hide the ownership of the property. If every other option has been exhausted, your friend has to understand that all is fair in love and money—they simply can’t pick and choose which assets are used to pay off their outstanding debts.

Walter Melanson is the co-founder and lead analyst at PropertyGuys.com, Canada’s largest private sale franchise network. A background in finance, economics and technology, Walter’s true passion lies in building a more modern approach to buying and selling real estate.

**Answer from Romana King, senior editor and real estate specialist at MoneySense:**

It’s tempting to hit reset. But life is not a video game. Sometimes you just can’t pause or hit the reset button, without serious consequences.

A consumer proposal or bankruptcy or two last-stop solutions; a last resort when all else fails. Despite their growing number, this step shouldn’t be taken lightly.

Now, it sounds as if your friend appreciates the ramifications of a bankruptcy; why else would he be trying to protect the assets he’s worked hard to acquire. But his logic is a bit faulty. To help us understand, I spoke to Debbie Gillis, of K3C Credit Counselling in Kingston, Ont.

“When someone owes money and is considering either a consumer proposal or bankruptcy, they must first apply for an assessment,” explains Gillis. This assessment takes into consideration all factors of a person’s finances, including whether or not they are still living in a home, if there’s any equity in the home and if they recently disposed of a property. The trustee responsible for the assessment will also examine current income, who’s on title for each property and what assets you currently owned or disposed of within the last year or so.

Now, your friend currently owns his home, so he would be on title. If he transferred ownership of this home to a relative, this would trigger a red flag during the assessment, particularly if he didn’t receive fair market value for the home (read more on FMV, here).

At this point, you may want to remind your friend that trying to hide his house using a family member’s name is considered fraudulent by the federal government; he and his relative could be charged and, if convicted, spend time in prison, under house arrest and/or be forced to make financial restitution.

Thankfully, committing fraud isn’t the only way for your friend to keep his home. Just because he needs to declare bankruptcy, doesn’t mean he has to sell his home to settle his debts, explains Gillis. It all depends on how much mortgage is owed, how much equity is in the home and what you currently owe, says Gillis.

To appreciate how all these factors determine the right course for your friend, let’s assume, for example, he owes $60,000 in debt, plus another $150,000 to the bank for the mortgage on his home, that’s worth $200,000 in today’s market.

Now if he sells the home he’d have $50,000, that’s currently equity in his home, to pay his debt. “At this point, he has two options,” says Gillis. “Sell, pay the debt back and then declare bankruptcy. Or stay in the house, go through a consumer proposal, pay off $50,000 to his creditors now and pay the rest off over time.”

In essence, the consumer proposal allows your friend to “buy back” the equity in his house, says Gillis, plus the proposal structures his remaining debt repayments over a certain period of time.

“If he wants to stay in his home, the best thing he could do is make sure his mortgage is low,” says Gillis. “The trustee will take into consideration the cost of paying the mortgage versus the cost of renting. If renting is more expensive, than it makes financial sense to stay in the house. He gets to keep his home, and can still complete a consumer proposal or declare bankruptcy to deal with his debts.”

This changes, however, if he has more equity in the home than debt. If your friend had $50,000 in equity, but owed $25,000 to creditors, he’d have to sell or refinance his home to repay the debt in full, explains Gillis. The benefit to this route is that he wouldn’t have to declare bankruptcy or adhere to the reporting and repayment schedules that are part of a consumer proposal.

“These are last resort options,” says Gillis, “and it’s a long road to see it to the end.”

For more on how to get out of debt, see:

Escape the debt trap »
How to avoid bankruptcy »
How to get out of debt »

Romana King is the senior editor and real estate specialist at MoneySense. She is also a licensed real estate sales agent. Follow her on Twitter (@RKHomeowner) or on Facebook. If you have real estate concerns or questions, please email Romana directly at [email protected] or call her on her direct line at 416-764-1382.