A homestead exemption is a legal provision that can protect your property from creditors and bankruptcy and reduce your property tax liability.
Homestead laws vary widely from state to state, but in this article, we’ll go over some of the basics behind how they work and how you can use them to your advantage.
What is a homestead exemption?
Basically, a homestead exemption is a form of asset protection. It helps shield your property against creditors when you declare bankruptcy or when your spouse dies. It’s designed to provide you with both financial protection and physical shelter.
Though homestead exemptions cannot block a foreclosure, which is considered a secured debt (the house being the collateral), a homestead exemption can block the forced sale of your house against unsecured creditors (like credit card companies).
Types of homestead exemptions
There are two main types of homestead exemptions: limited and unlimited ones. A limited homestead exemption protects your property up to a certain value, say $50,000. Any claim that goes beyond that will leave your property exposed to creditors.
Other states like Texas and Florida provide unlimited homestead protections, meaning there is no limit to the property value it will protect. However, there may still be acreage limits.
Who is eligible for a homestead exemption?
Eligibility for homestead exemptions varies by state, but most have some sort of exemption for low-income individuals, seniors, veterans, law enforcement, and the disabled. Only New Jersey and Pennsylvania have no homestead exemption.
Homestead exemptions can also only be claimed on your primary residence. Other residences won’t qualify.
How does a homestead exemption work?
In some states, homestead protection is automatic. In others, you must file for an exemption with the state. This means filling out an application with your tax office and answering some basic questions about the property and the type of exemption you are seeking.
If the homestead exemption is based on eligibility, you may also need to provide documents that prove your status as low-income, veteran, senior, and so on.
Homestead exemptions only protect your equity in a house, not its full value. So if you have a mortgage on a $500,000 house and you’ve paid off $100,000, your home will only be protected up to $100,000.
When it comes to bankruptcy, some states let you choose between state and federal bankruptcy exemptions. But you can’t choose both. Federal law will currently shield your home from a forced sale if your equity does not exeed $27,900.
Property tax benefits
Homestead exemptions can also reduce the value of your home subject to property tax. There are flat-dollar and percentage exemptions.
A flat-dollar exemption reduces the taxable value of your property by a set amount, say $50,000. So if your house is worth $300,000, you’d only be taxed on $250,000. This also means the lower the value of your house, the more beneficial a flat-dollar tax exemption becomes.
A percentage exemption reduces the taxable value of your house by a certain percentage, like 20%. So if your house is worth $300,000, you’d only be taxed on $240,000. This means the higher the value of your house, the bigger impact the percentage exemption will have.
Putting it all together
Homestead exemptions can be complicated. You’ll want to verify what your state’s exemption laws are, but at least you now know the basics behind how they work. Be sure to consult an experienced asset protection attorney if you need professional help.