Bankruptcy Can Be a Great Investment.

• Author: SCHNEPPER, JEFF A.
• Position: Brief Article

WANT TO DOUBLE OR TRIPLE your net worth? Want the best investment in town? It's easy--just go bankrupt! If you do it right, you can keep all your assets and eliminate all your debts---even those owed to the Internal Revenue Service.

(Bankruptcy originally meant broken bench. In common-law England, when a merchant or craftsman couldn't pay his debts, the custom in the community was to break his workbench. This publicly established that the craftsman was no longer in business. Quite often, the creditors at that time would seek to perform the ceremony across the head of the impecunious debtor.)

Things have changed since I was a kid. Now, bankruptcy laws are used as proactive shields not only to deflect creditors, but to eliminate them as well. While the bankruptcy law itself is Federal, the exemptions are state-derived. Each state determines which assets are forfeited in a bankruptcy and which assets are exempt from creditors.

For example, Florida exempts your "homestead" from bankruptcy. This means that, if you go bankrupt in Florida, you are able to keep and protect your homestead--where you live and the land surrounding it.

When the banking scandals erupted in California and massive judgments were assessed against bank officials, they moved to Florida. There, these well-advised, but ethically challenged, officials liquidated their other assets and used those funds to purchase multi-million-dollar homes. Then they declared bankruptcy.

The result was that all of their debts were wiped out and they were allowed to keep their multi-million-dollar homesteads. By declaring bankruptcy and erasing all of their debts while keeping all of their assets in a homestead form, they multiplied the value of their net worth--all within the law. Many subsequently sold their homesteads and were returned to debt-free financial liquidity.

What about the debt that was extinguished? If the IRS normally considers "debt relief" taxable income, wouldn't bankruptcy create a huge tax liability? Not in this case! The bankruptcy law and the Internal Revenue Code specifically exclude debt relief under the U.S. Bankruptcy Code as "income."

So, what do you have so far? You get to keep all your assets. You lose all your debts. You have no tax on your debt relief. However, while you can lose your normal creditors in a mass of legal convolutions, nobody beats the IRS with respect to taxes owed--right?

Not necessarily. You see, there is another set of convoluted rules with...