Business Law

Homestead Exemption Doesn’t Extend to Other Structure On Debtors’ Lot with Renters, BAP Affirms

The following is a case update written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, analyzing In re Rey, a recent case of interest:

SUMMARY

In the case of In re Rey, 657 B.R. 634 (9th Cir. BAP March 29, 2024), the Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”) affirmed the decision of the bankruptcy court to limit the Debtor’s homestead exemption claimed under California Code of Civil Procedure (“CCP”) § 704.730(a)(1) to only the building in which Debtor resides, and not to a separate building on the same lot owned by Debtor occupied by renters.

To read the decision, click here.

FACTS

Maria Teresa Melendez Rey (“Debtor”) filed a Chapter 7 bankruptcy case in July 2022. In November 2022, Debtor moved to convert her case to Chapter 13, subject to being reconverted to Chapter 7 if the Chapter 13 failed.

In Debtor’s schedules, she disclosed a real estate asset of 1922-1924 Bunker Ave (“Property”). She described the property as “two houses on parcel…” one in which Debtor resides, and the other rented by two sisters. She valued the Property at $930,000, with a secured debt of just over $580,000, and then used the homestead exemption of $626,400 to protect the lot with both the residence and rental unit. Or so she thought.  Id. At 639.   Key among the facts is that the two structures were separated by a fence, had separate addresses, with separate driveways, separate entrances, separate parking, separate utilities, and separate mailboxes.  Id. At 639. 

Given all that, unsecured creditor Peter Urquijo (“Creditor”) objected to the homestead exemption on the basis that the exemption did not extend to the rental duplex. Aside from the above facts, another factor Creditor noted is that Debtor had not entered the rental unit since 2020, and in fact, was prevented from doing so by the terms of the lease, absent notice. In further support, Creditor provided two separate appraisals for the structures: the first valued at $574,000, and the rental unit at $830,000.  Id. At 639. 

Debtor opposed Creditor’s objection, focusing on the fact that the structures were on a single parcel of land subject to a single assessor’s parcel number. Debtor maintained that because she resided in one structure on the parcel, the entire parcel was exempted, and subject to a single parcel number, could only be sold as a single unit under California real estate law. The rental unit, she maintained, was an “outbuilding” on the lot she owned, regardless of how the building was used.

The bankruptcy court ruled in favor of Creditor and sustained the objection. In so doing, it relied on Creditor’s view of the homestead exemption law and specifically rejected Debtor’s claim that two structures on a single plot of land must be treated as one unit.  See 2023 WL 4305814, p. *2. 

Debtor appealed to the BAP, which affirmed the bankruptcy court’s ruling.

REASONING

The BAP started with definitions of the relevant terms. A homestead is “the principal dwelling: (1) in which the judgment debtor… resided on the date the judgment creditor’s lien attached to the dwelling, and (2) in which the judgment debtor… resided continuously thereafter until the date of the court determination that the dwelling is a homestead.” CCP § 704.710(c)

A dwelling is “a place where a person resides and may include but is not limited to… [a] house together with the outbuildings and the land upon which they are situated.” CCP

§ 704.710(a)(1) (emphasis added by BAP).

The definition of dwelling, then, matters, especially in determining which outbuildings and land are protected. Going back to jurisprudence almost two centuries old, the BAP then noted that California includes “the usual and customary appurtenances, including outbuildings of every kind necessary or convenient for family use and lands used for the purposes thereof.” Gregg v. Bostwick, 33 Cal. 220, 227 (1867). 

The Gregg case involved a declaration of a homestead exemption of real property with four lots, where the debtor lived on one lot. The other lots in Gregg were separated by fences and included six other dwelling houses. The California Supreme Court in Gregg said the only tests for consideration were use, and value, adding:

Whatever is used–being either necessary or convenient–as a place of residence for the family as contradistinguished from a place of business, constitutes the homestead, subject to the statutory limit as to value. If, however, it is also used as a place of business by the family, which frequently happens, it may not therefore cease to be a homestead, if it would be necessary or convenient for family use independent of the business.

Gregg at 228.

The BAP found “[t]he extent of Rey’s homestead exemption ultimately hinges on how she used the Property” (Id. At 642), as it continued its review of Gregg:

…[T]he homestead is not measured by fences merely. As fences alone cannot limit the extent of the homestead, neither can they enlarge it. Its extent is measured by use and occupation as such, and not by imaginary or artificial lines.

Gregg at 228-229.

The BAP then dismissed Debtor’s insistence that outbuildings must be included in the homestead exemption, emphasizing the statute’s language of “may include.” To be part of the permissive – not mandatory – inclusion in the homestead exemption, the outbuildings must be subject to a fact-intensive investigation regarding debtor’s use. In the BAP’s subsequent review, it then examined, and dismissed, some cases put forth by Debtor in support of her homestead of the entire lot. 

One such case is where the parcel in question involved four houses on different lots, where the debtor there lived in one and rented out the other three. In re Jarrell, 34 F. 2d 970 (S.D. Cal. 1929). The Jarrell court found that “all of the property is necessary and convenient for the use of the bankrupt and his family as a place of residence, independent of the smaller residences upon said property which are rental properties” and “the entire parcel was covered by lawns, gardens, and “pagodas” that were part of debtor’s residence.” Jarrell at 974.  The BAP questioned and then distinguished Jarrell from Debtor’s facts, pointing out that the Property at issue has many factors that indicate the rental duplex was separate from Debtor’s residence where Jarrell wouldn’t apply.  Id. At 644. 

Next, the BAP dismissed Debtor’s claim that a homestead cannot be forcibly subdivided, saying this argument was “not supported by California law.” Id. At 646. It then underscored that the determining factor is Debtor’s use, and then, after that fact-based determination, the value of what can be exempted. “[T]he absence of any division, or even the indivisibility of the property, does not expand or contract the

applicable exemption.” . Notably, the BAP added that to the extent California law prevents forced partitioning and sale of homesteads, that’s a “problem best addressed by the California legislature.” Id. At 646-647.

Finally, the BAP addressed Debtor’s economic necessity of the rental property income. Even though this argument was raised for the first time on appeal and lacked evidence, the BAP said that even if true, this alone does not transform the rental property into a dwelling for purposes of the homestead exemption. Id. At 647.   In doing so, it distinguished a case put forth by Debtor where access to the rear house could only be accomplished by crossing over land used by that debtor’s front house, which again, is not the same fact pattern as Debtor’s rental building, with separate everything.  Id. At 647-48. 

After distinguishing another case or two Debtor put forth, the BAP then summarized the law thusly: “Absent unusual circumstances, California treats separate dwellings not used as the debtor’s residence as not part of the debtor’s homestead. See In re Est. of Schmelz., 259 Cal. App. 2d at 444-45; Lubbock, 82 Cal. at 229 (following general rule); Maloney, 75 Cal. at 424–25 (same).” Id. At 648. 

AUTHOR’S COMMENTARY

At first blush, this ruling which holds that a building on debtor’s land may not be protected by the homestead exemption is terrifying for debtors. During a time where California has a housing crisis and accessory dwelling units (ADUs) are being encouraged, this development would in fact discourage homeowners from renting out buildings on their properties, lest they lose them to a judgment creditor in a possible bankruptcy.

But a careful reading of the BAP opinion points out specific facts in the Rey case that made it unique, or at least should, going forward. Debtor here had constructed the rental property with many details separating it from her own residence (fencing, mailboxes, driveways, et al). The case law interpreting a “dwelling” for homestead purposes emphasizes the Debtor’s use of the buildings in question. If homeowners go out of their way to make a rental unit separate where debtors have no use, the result is that the courts may very well agree with them. This isn’t to suggest that a homeowner needs to create pagodas to connect rental units with their own residence (as in Jarrell, supra), but they also shouldn’t make rentals so separate that they are no longer necessary or convenient for use by the homeowner.

This isn’t to say that removing fencing to blend structures would entirely protect a homeowner. The BAP majority says the rule is that California treats separate dwellings not used as the debtor’s residence as not part of the debtor’s homestead, after it distinguished a host of exceptions to that rule. Despite the Gregg precedent being from the time of California’s settlers, due to changes in California since then, this area of law appears to be still unsettled.

Note that the Calif. Supreme Court in Gregg allows a structure to be used for business purposes (such as rental income) without losing the homestead: “If, however, it is also used as a place of business by the family, which frequently happens, it may not therefore cease to be a homestead, if it would be necessary or convenient for family use independent of the business.” Gregg at 228. The rental income itself doesn’t doom a structure; the building just still needs to be “necessary or convenient for family use” regardless of the business, which wasn’t the case here, if “use” is defined to exclude economic benefit.

It’s also worth highlighting the concurrence by Judge Frederick Corbit. In it, Judge Corbit agreed with the ultimate rationale and holding that the homestead exemption is only limited to the structures a debtor uses. Further, he notes that California property is no longer easily divided, as it was at the time of the 1800s when Gregg was decided barely 25 years after the California gold rush. Moreover, Judge Corbit also highlights the recent encouragement of Californians to build ADUs. Concluding, he then emphasized the need for the California legislature to “address how the California homestead statute applies to debtors who live in only one of the multiple residences on a single lot.” Concurrence at *2. The laws need to be changed.

Judge Corbit is right. The majority focused on Debtor’s use of property being rented out based on a post-Civil War case, and found none. However, a homeowner’s decision to use part of a lot for rental purposes – whether for economic necessity, altruistic helping with our housing crisis, or even as a business as Gregg noted – is still use. As such, a decision to lease part of one’s land should not risk losing some of their valuable real estate property. California’s legislature should take immediate action to extend the homestead exemption to the full lot owned by Californians, which would protect homeowners and encourage use of their properties for rental use, to the benefit of all.

These materials were written by Hale Andrew Antico, Chief Counsel of Antico Law Firm, representing consumer debtors in the Central District of California, and President of the Central District Consumer Bankruptcy Attorneys Association, with editorial contributions by Kathleen A. Cashman-Kramer, Director at Fennemore LLP (kcashman-kramer@fennemorelaw.com ).


Forgot Password

Enter the email associated with you account. You will then receive a link in your inbox to reset your password.

Personal Information

Select Section(s)

CLA Membership is $99 and includes one section. Additional sections are $99 each.

Payment