Depriving local governments of tax revenue is like cutting off oxygen to the body–they can’t live without it.  Local governments and schools in Nebraska depend on a steady flow of real estate tax revenue to keep their doors open.

To prevent cash flow problems caused by homeowners who fail to pay real estate taxes on time, Nebraska county treasurers  sell Tax Lien Certificates to investors for the unpaid taxes.  The investors earn 14% interest on their investment and if the certificates are not redeemed by the homeowner within 3 years, the investor make take ownership of the property by requesting a Treasurer’s Deed.

Although the investments are subject to risk, the potential to earn staggering profits is significant.  I’ve seen homes worth $100,000 lost for unpaid taxes of less than $5,000.  Most taxpayers over the age of 65 are not required to pay real estate taxes if they apply for the Homestead exemption annually, but with advanced age comes a loss of memory and it is not uncommon for the elderly to lose their homes when they fail to apply for the exemption.

WILL FILING BANKRUPTCY RECOVER A HOME LOST TO UNPAID TAXES?

A recent case from the 7th Circuit Court of Appeals provides an example of how filing bankruptcy may allow a homeowner to recovery a home lost for unpaid real estate taxes.  In that case (In re Smith, 526 B.R. 737), Keith and Dawn Smith owed $4,046.26 of real estate taxes.  The Illinois county treasurer sold a tax lien certificate to an investor for the unpaid taxes and when the Smiths failed to redeem the certificate by not paying the tax and accrued interest within the required time, the investor became the owner of the home.  The investor subsequently sold the property to another investor for $50,000.  Wow, that is almost 10 times the original investment price!

The Smiths filed a Chapter 13 bankruptcy and commenced an adversary complaint seeking to avoid the tax sale of their property.

BANKRUPTCY CODE SECTION 548(a)(2)

Under Section 548 of the bankruptcy code a transfer of a debtor’s property made within 2 years of the bankruptcy petition for less than “reasonably equivalent value” may be avoided.  May a person in bankruptcy utilize section 548 to recover a home lost in the prior 2 years to a tax certificate sale?

CASE LAW BACKGROUND: BFP v RESOLUTION TRUST CORP

As a general rule, homes lost to foreclosure sales cannot be recovered even if the foreclosure sale price is significantly less that what a home would fetch if it were sold through a normal real estate listing.  In 1994 the Supreme Court issued a ruling in BFP v. Resolution Trust Corp (511 U.S. 531) stating that the sales price obtained in a foreclosure sale is considered “reasonably equivalent value” as a matter of law, even if the sales price is far below what a property would sell for under normal market conditions.  In other words, there is no opportunity to complain about the low price because that is just the nature of foreclosure sales where buyers must pay the full purchase price at the time of sale or shortly thereafter.  As long as the state foreclosure procedures were followed the sales price is final.

The 7th Circuit,  however, pointed out that the Illinois tax sale procedure is unlike the competitive bidding process present in the BFP case.  In fact, the Supreme Court specifically stated that the BFP opinion “covers only mortgage foreclosure of real estate.  The considerations bearing upon other foreclosure and forced sales (to satisfy tax liens, for example) may be different.” (page 537, footnote 3).

There is no competitive bidding process in the sale of tax certificates in Illinois.  Rather, Illinois utilizes an Interest Rate Method when selling tax certificates that does not involve competitive bidding between prospective investors. (Under the Interest Rate Method there is competitive bidding as to the interest rate paid, but not as to the price of the certificate.)  Because Illinois does not employ competitive bidding when selling tax certificates the sale is subject to being avoided in a bankruptcy proceeding if the sales price is substantially less than the true market value of the property.

TENTH CIRCUIT OPINION: SHERMAN V. ROSE

The 10th Circuit Court of Appeals has also allowed debtors to attack property transfers involving unpaid tax certificates.  In the case of In re Sherman, 223 B.R. 555, a Wyoming property was transferred to an investor for unpaid taxes of only $500.  Under Wyoming law, the tax certificate was sold to an investor “selected in a random lottery for the amount of the outstanding taxes. The Wyoming tax sale statutes do not permit a public sale with competitive bidding.”  Since there was no competitive bidding in the sale of the tax certificate the 10th Circuit ruled that the sale was subject to the bankruptcy court’s avoidance powers.

NEBRASKA TAX CERTIFICATE SALE PROCESS

Nebraska utilizes a “Round Robin” format very similar to Wyoming system in selling tax certificates.  The procedure is provided in Nebraska Statute 77-1807. (A good description of the process is provided here.) In a Round Robin auction investors must register to buy certificates that are sold on the 1st Monday of March each year.  The order of the auction is determined by randomly selecting an investor from the list of registered participants.  There is no competitive bidding on the price of the certificate.  Each certificate is sold for exactly the amount of the unpaid taxes.

There is no case law in Nebraska on this topic yet, but it would appear that the Nebraska procedure for selling tax certificates is substantially the same as the Illinois and Wyoming procedure and debtors (as well as Chapter 7 Trustees) should be able to recover their homes lost to a tax certificate sale if the sales prices is substantially less than the home’s fair market value.

Keep in mind that this option is only available when a tax certificate buyer obtains title to the property by acquiring ownership through a Treasurer’s Deed.  Property purchased by investors at a real tax foreclosure auction sale that involves competitive bidding would probably be protected under the Supreme Court’s BFP decision.

Have you lost a home in the past 2 years due to unpaid real estate taxes?  Contact our office for a free consultation regarding your options.

Image courtesy of Flickr and davitydave.