What is Equity?
Before starting Schedules A and B, the listing of real and personal property, and Schedule C, property claimed as exempt, a person must understand how the calculate any equity that might be available to the trustee. Remember, the trustee’s job is to determine if there is any property that he can sell to get cash from which to make a partial payment, or distribution, to creditors. The trustee can only reach the equity in the property that the debtor owns at the time she filed bankruptcy.
Equity is the value of the property above the amount owed to creditors who hold security in the property for their debts. You can find a discussion of secured and unsecured debt here.
How to Calculate Equity
There are only two steps to calculating a person’s equity in her property. The first is to determine the value of the property. The second is to subtract from that the amount of secured debt.
Calculating Value. This is the hardest step because value means the market value of the property on the day the debtor files bankruptcy. It doesn’t mean what the debtor paid for the property, nor does it mean what the debtor would have to pay to replace the property.
Value is easy to calculate for financial assets such as bank accounts; retirement accounts; and stocks and bonds and other investments traded on recognized exchanges. The value of a bank account is the balance in the account. The same is true of retirement accounts. The value of a retirement account is the total value on the day of filing as shown by a statement from the company that handles the account. The value of stocks, bonds and other investments traded on recognized exchanges is the published market price on the day of filing, or a day very near the day of filing.
The value of real estate is most often established by the prior year’s property tax valuation. But beware! In some counties, the assessor has not re-valued the property for several years. In such counties the market value might be substantially higher (most often) or lower (rarely) than the tax valuation. So, it’s good to have a general idea of the current value from recent sales of similar properties.
Household goods and furnishings are generally valued by what the debtor thinks she could get for each item at a yard sale. For example, if the debtor were to sell her refrigerator, what does she believe someone would be willing to pay for it? In most cases, these will be quite low values; after all, who will pay very much for a 15-year old stove?
If the debtor has collectibles, such as coins, stamps, baseball cards or anything similar, and the collection is extensive or includes some rare items, it is advisable to have an appraisal done by a qualified appraiser.
Interests in business are probably the most difficult property interests to value. One common method is to use the balance sheet: assets of the business are totaled, as are liabilities. The total liabilities are subtracted from the total assets to arrive at the net worth, net equity, or owners’ equity, as it is sometimes called. The net equity is then multiplied by the percentage ownership that the debtor owns in the business. For example, suppose the business is jointly owned by the debtor and her business partner, 50% each. The net equity of the business would be multiplied by 50% (.50) to arrive at the debtor’s value in the business. The balance sheet method relies on the historical cost of the assets, so it is very often not accurate, especially for a going concern. If the business is making a profit, it could have substantial value even though the balance sheet method shows it has a small or even negative net equity. For going concerns that are making a profit, it’s best to have the business valued by a business appraiser. If the calculated net equity of the debtor’s interest in a business is less than zero, the business interest is listed as having zero value.
Secured Debt. Once the value of each individual item of property is determined, the debtor subtracts from that value the balance of any debt that is secured by the property. This, of course, means the debtor must also know how much secured debt is against the property. This is usually the easy part. The debtor knows if there is a mortgage on her house, or if the bank holds title to her car. The balance of the loan is typically given in the monthly statements the debtor receives from the bank.
Calculating the Equity. Suppose the debtor determines that her car has a value of $17,000 from the Kelly Blue Book online guide. She then looks at how much (if anything) she owes to the bank or finance company through which she is buying the car. If she owes the bank $12,000, then she has equity of $5,000 ($17,000 minus $12,000) in the car.
What Happens to the Equity?
That equity, or a portion of it, could be subject to the bankruptcy trustee.
The portion that is subject to being taken by the trustee is any amount of equity that remains after deducting any exemptions to which the debtor is entitled under state law. In a later post we’ll talk about exemptions. For now, it’s enough to know that a person must calculate equity in her property so she can assess whether any of it is subject to the trustee’s claims.
As you can see, calculating equity properly is important! You could lose thousands of dollars if it isn’t done correctly. And, just because you give a value doesn’t mean the trustee is required to accept that value. The trustee can ask for an appraisal or independent valuation of any of a debtor’s property. If the debtor and the trustee disagree over value, it will be up to the bankruptcy judge to determine the value.
If you have any bankruptcy questions, contact us here, or call or text (801) 413-3708, or email email@example.com .