Proceeds from Exempt Assets

April 13, 2006

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Asset exemption planning involves the conversion of nonexempt assets into exempt assets. While the opposite of exemption planning should never be voluntarily undertaken, in reality it will sometimes be inevitable. For example, life insurance will be converted to cash upon the death of the insured. Exempt wages will be received, and become simply "cash," a nonexempt asset. In each of these cases, what was once an exempt asset loses its exempt status.

Ideally, when this happens, a plan will be in place to apply the cash proceeds to an exemption (e.g., by paying down a mortgage on a home with an unlimited homestead exemption, by making a contribution to a retirement plan, by making a gift in return for a private annuity, etc.).

Nevertheless, because of the unfairness of an involuntary conversion to a nonexempt form, many states provide that the proceeds from certain exempt assets are, in turn, exempt for a certain period of time.

This exemption applies only to certain listed exempt assets, usually life insurance (subject to restrictions) and, in some states, the homestead and earned but unpaid wages. The exemption is relatively short-lived, typically being in a range of two to 18 months. For homestead proceeds that are reinvested in a new homestead, a new federal law as of October 17, 2005, states the equity must have been acquired at least 1,215 days before a bankruptcy filing for the proceeds to be considered exempt. The exception here is life insurance proceeds, which, subject to certain restrictions, are simply exempt in many states regardless of the time that elapses, or the number of times that the proceeds are re-invested into different forms.

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Even where there's a generous exemption, it is doubtful that life insurance proceeds will remain exempt forever. Assume that, even in this situation, the exemption will expire eventually, but at the same time save records as if the exemption will never expire, on the outside chance that an asset acquired with the proceeds, even years later, may still be exempt.

In every case involving exempt proceeds, it is important to be able to trace and separately identify the proceeds, in whatever form they exist in the future. Records should be established that detail the trail of the proceeds. They should be retained, along with copies of supporting documentation, for at least the life of the new exemption or, in the absence of a fixed expiration period, indefinitely.

In Idaho, sales proceeds from an exempt homestead are exempt for six months, while the period is one year in Illinois.

Many states do not exempt proceeds from the sale of an exempt homestead. Thus, caution should always be exercised before selling any exempt asset--in particular, the homestead--because of its value.

Florida exempts the amount of allowable wages received in the six months prior to an attachment or bankruptcy action, provided the proceeds have been deposited into a bank account. This is an especially generous exemption, because the wage exemption in Florida is unlimited for heads of household; in most other states, only earned but unpaid wages will qualify for this exemption (you can examine your state's exemptions in the exemption list to determine whether, and to what extent, your state exempts the proceeds received from the disposition of exempt assets).