The homestead exemption is designed to protect the equity in a debtor’s principal residence. When a debtor files for bankruptcy and has an interest in a principal residence, a portion or all of the equity interest in the homestead is protected. The level of protection the homestead exemption offers varies state by state.
While the homestead exemption allows a debtor to protect a portion of his principal residence from bankruptcy creditors, the protection is not absolute. 11 USC 522(o) allows a trustee or creditor to challenge a debtor’s homestead exemption and provides a look back period of 10 years. Stated differently, the Court may look back 10 years to discover how a debtor obtained the money to purchase his or her home. A Section 522(o) action is fact intensive and is decided on a case-by-case approach.
Section 522(o)(4) of the Bankruptcy Code provides that the value of a debtor’s homestead exemption claimed under Section 522(b)(3)(A):
shall be reduced to the extent that such value is attributable to any portion of any property that the debtor disposed of in the 10-year period ending on the date of the filing of the petition with the intent to hinder, delay, or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt, under subsection (b), if on such date the debtor had held the property so disposed of.
Thus, “under this section a debtor may not claim as exempt homestead property any portion of the homestead that was (1) acquired with assets not exempt under § 522(b), and (2) acquired with actual fraudulent intent to defraud a creditor.” In re Klinglesmith, ___BR___; 2011 Bankr. LEXIS 2230, at *13 (Bankr MD Fla, June 2, 2011). The trustee’s bears the burden on both elements and must prove by a preponderance of evidence that the debtor had the actual intent to “hinder, delay, or defraud a creditor.” Id. at *2.
In most cases, the trustee can prove that the homestead was acquired with assets not exempt under Section 522(b). See e.g. Clark v Wilmoth (In re Wilmoth), 397 BR 915, 919 (BAP 8th Cir, 2008) (finding the trustee met his burden on the first elements because the debtor sold some his business equipment to pay down his mortgage before filing for bankruptcy). The cases of Clark and Klinglesmith are the classic examples of the debtor selling property and transferring the proceeds from the sale to the homestead. See In re Klinglesmith, ___BR___; 2011 Bankr. LEXIS 2230, at *13 (Bankr MD Fla, June 2, 2011) (the debtor sold a mental care facility and transferred a portion of the money to the homestead); Clark v Wilmoth (In re Wilmoth), 397 BR 915, 919 (BAP 8th Cir, 2008) (the debtor sold equipment and transferred the proceeds to the homestead). In those situations, the trustee will likely prevail on the first element.
While the trustee usually meets his burden of proof on the first element, the trustee usually fails to demonstrate by a preponderance of the evidence that the debtor had the actual intent to “hinder, delay, or defraud a creditor.” In re Klinglesmith, ___BR___; 2011 Bankr. LEXIS 2230, at *13 (Bankr MD Fla, June 2, 2011). Given the difficulties of discerning a debtor’s subjective state of mind, bankruptcy court typically assess whether the debtor had the requisite fraudulent intent by looking to the badges of fraud. Id. at *16. In Michigan, the badges of fraud are enumerated in MCL 566.34(2) and are attached hereto. “The presence of one badge of fraud does not necessarily establish fraudulent intent, while a confluence of badges can constitute conclusive evidence of an actual intent to defraud.” Id. at *14 (citations and quotations omitted). Even when the trustee can demonstrate some badges of fraud, several Circuit require an additional showing – extrinsic evidence of fraud. See Clark v Wilmoth (In re Wilmoth), 397 BR 915, 919 (BAP 8th Cir, 2008) (“[A] debtor's conversion of non-exempt property to exempt property on the eve of bankruptcy for the express purpose of placing that property beyond the reach of creditors, without more, will not deprive the debtor of the exemption to which he otherwise would be entitled.”) (citations and quotations omitted). In other words, to meet the trustee’s burden, he must demonstrate that the debtor had a deliberate and strategic plan to defraud creditors. See In re Roberts, 527 BR 461, 478 (Bankr ND Fla, 2015) (finding the trustee sustained his burden because the debtors intentionally misinformed their creditors and converted all of their non-exempt property in an attempt to hide behind the homestead exemption). Thus, the trustee in any Section 522(o) proceeding faces an uphill battle to meet his burden of proof.
In sum, the trustee usually will be able to meet his burden of proof and demonstrate that the homestead was acquired by non-exempt property. However, bankruptcy courts are reluctant to find that the trustee has proven by a preponderance of evidence that the debtor engaged in actual fraud when he transferred the non-exempt property to the homestead.
 This was the only case that this writer could find where the Trustee sustained his burden of proof on a Section 522(o) action.