United States: Delinquent Property Taxes: Beware The Risk Of Tax Deeds

Last Updated: February 4 2014
Article by Vicki Harding

Smith v. SIPI, LLC (In re Smith), 501 B.R. 843 (Bankr. N.D. Ill. 2013) –

Chapter 13 debtors (the Smiths) lost their residential property in a pre-petition delinquent property tax sale.  The tax sale purchaser (SIPI) resold the property to a third party (Midwest).  The Smiths sought to avoid the tax sale as a fraudulent transfer.

Ms. Smith inherited the property from her great-grandfather.  At that time it was encumbered by a lien for delinquent real estate taxes.  SIPI purchased the delinquent taxes for ~$4,000, paying a total of ~$5,000 for the property, including costs.  The Smiths did not redeem the delinquent taxes or pay subsequent taxes owing on the property.  Consequently, SIPI obtained a tax deed, which was recorded.  It then sold the property for $50,000 and executed a warranty deed in favor of Midwest.

Approximately two years later the Smiths filed bankruptcy and simultaneously filed an action against both SIPI and Midwest to avoid the tax sale as a fraudulent transfer under Section 548 of the Bankruptcy Code.  The debtors listed the property in their schedules as having a value of $90,000 and claimed a homestead exemption of $15,000.

Initially the lower courts held that the tax sale transfer was perfected upon expiration of the redemption period, and thus was not within the two-year "look back" period of Section 548.  However, on appeal the Seventh Circuit determined that the transfer was not perfected until the tax deed was issued, and thus the avoidance action was timely.

Under Section 548(a)(1)(B) a transfer may be avoided if a debtor (1) receives less than reasonably equivalent value and (2) was insolvent or became insolvent as a result of the transfer.  Given that the Smiths owned minimal assets other than the property, the court concluded that it was clear that, at a minimum, they became insolvent as a result of the tax sale.

This left the issue of "reasonably equivalent value."  The purchasers argued that this case was governed by the Supreme Court decision in BFP v. Resolution Trust Corp., 511 U.S. 531, 114 Supreme Court 1757, 128 L.Ed.2d 556 (1994), which held that the price received at a foreclosure sale constituted reasonably equivalent value as a matter of law as long as state law requirements were met.

However, the BFP decision includes a statement in a footnote that there might be different considerations in other contexts, such as a forced sale to satisfy tax liens, and the Smith court noted that:  "Courts have generally held that BFP does not apply in the tax forfeiture context, particularly where competitive bidding is not a component of a tax sale statute."

In other words, if there is no public sale or competitive bidding, it should not be presumed that a debtor received reasonably equivalent value as a matter of law.  In this case the only purpose of the tax sale was to obtain payment of delinquent taxes.  Thus there was no correlation between the sale price and the value of the property.  And since there was no opportunity for competitive bidding, there was no assurance that fair value was received.

The court next considered whether the Smiths did in fact receive reasonably equivalent value.  They provided an appraisal showing that the fair market value of the property was ~ $110,000.  However, the court concluded that it did not need to determine value, but only whether the value of the property was greater than the debtors' exemption amount of $15,000.  Since Midwest paid $50,000, the court concluded that the value was somewhere between $50,000 and $110,000 – which in either case was more than $15,000.

Thus, the Smiths gave up equity of ~ $46,000 to ~ $106,000 in exchange for being released from a tax obligation of ~ $4,000.  Since they received about 3.8% to 8.8% of the value of the property, the court determined that they clearly did not reasonably equivalent value.

Turning to liability, under Section 550 a fraudulent transfer can be recovered from the "initial transferee" (SIPI) or from an "immediate or mediate" transferee of the initial transferee (Midwest). However, Midwest, as a subsequent transferee, successfully asserted a defense that it acquired the property for value, in good faith, and without knowledge of its voidability.  Under the circumstances, the court found that only SIPI was liable.

Consequently, the court avoided the tax sale transfer as a fraudulent conveyance to the extent of the homestead exemption of $15,000, which the Smiths could recover from SIPI.

It is clear that a purchaser runs the risk that a property tax sale (or other forfeiture procedure) that does not include competitive bidding will potentially be subject to avoidance if the property owner subsequently files bankruptcy.  (For example, see Delinquent Property Tax Foreclosure: Is There "Reasonably Equivalent Value" or Not?.)  Since this was a Chapter 13 case, the debtors had to rely on Section 548 of the Bankruptcy Code, and thus were limited to transfers that occurred within 2 years prior to the bankruptcy  However, a Chapter 7 trustee or Chapter 11 debtor could also bring a fraudulent transfer claim under state law using Section 544 "strong arm" powers, and the statute of limitations under state law is typically 4 years.  Thus, depending on the type of bankruptcy that is filed, a purchaser could have potential post sale liability for a significant period of time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Vicki Harding
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