Over the last 100 years or so counties have operated under the assumption that if property taxes (or in some cases water/sewer, etc…) are not paid then the county can “take” the property for the unpaid taxes. A recent supreme court ruling radically alters this theory and places huge liabilities on anyone buying tax liens. What is the case about? Who won/lost? What does this mean for individuals and cities/counties trying to collect taxes? Should you buy a tax lien after this ruling?
What was the tax lien supreme court case about?
After 94-year-old Minnesota resident Geraldine Tyler failed to pay property taxes on her former home in Hennepin County, the County seized the property and sold it at auction for $40,000. Even though Tyler owed only $15,000 in past-due taxes, interest, and costs to the County, pursuant to Minnesota law, the County retained the surplus $25,000 from the sale rather than refunding it to Tyler.
Tyler filed suit against the County, arguing that by keeping the extra $25,000, Hennepin County violated the Excessive Fines Clause of the Eighth Amendment (among other constitutional provisions).
What did the supreme court rule?
The Supreme court rules unanimously in favor of Tyler that the county “took” her property
The Takings Clause, applicable to the States through the
Fourteenth Amendment, provides that “private property
[shall not] be taken for public use, without just compensa-
tion.” U. S. Const., Amdt. 5. States have long imposed
taxes on property. Such taxes are not themselves a taking,
but are a mandated “contribution from individuals . . . for
the support of the government . . . for which they receive
compensation in the protection which government affords.”
Why are investors liable for buying a tax deed?
The Court reasoned that when a tax-certificate holder obtains a tax deed, they effectively “exercised a privilege created by the State in order to seize property.” The exercise of this privilege resulted in a tremendous benefit to the tax-deed holders, and even a windfall in some circumstances. So, the Court reasoned that imposing the potential risk for paying just compensation on the tax-certificate holder was appropriate. After all, it was the tax-certificate holder who chose to pursue the deed-application process instead of filing for traditional foreclosure.
Why is this case so historic?
Prior to this case, counties had free reign to collect unpaid taxes, even if someone owed just 1 dollar on a million dollar property, the county could collect and ultimately an investor could take the property through a treasurer’s deed. This created a lucrative market for tax lien sales where the county would sell its uncollected property taxes to investors, immediately getting cash and the investor would get a statutory rate of return and possibly the property if the tax lien was not redeemed.
What is the new process for tax liens?
Currently in most states, when a buyer purchases a tax lien, if the lien is not paid within x years, the tax lien buyer can file for a trustee deed to the property. Based on the recent ruling this is no longer allowed due to the huge liability to the tax lien buyer. Now, in order to get a deed the county should initiate a foreclosure action and any excess above the tax lien amount must be returned to the owner (or other creditors). Long and short, the upside for tax lien buyers has been eliminated.
Ruling radically alters the economics of tax liens
Based on the ruling by the Supreme court, the entire economics of buying property tax liens has been eliminated. With the ruling there is a risk for tax lien buyers and the upside potential has been eliminated. Let’s look at Colorado for example, today the rate of return could be anywhere from 8% to 15% depending on whether someone claims that there tax lien was improperly sold. Furthermore, if the claimant is correct, the tax buyer could actually end up owing the claimant money if courts find that the equity was “stripped” from the property due to a tax lien sale.
Ruling raises some huge questions about tax liens going forward
The implications of this ruling are far reaching and raise some interesting questions that will only be resolved through case precedent going forward.
- Bankruptcy: Under the new paradigm from the ruling, to be safe the property should be sold via a foreclosure auction. Foreclosure auctions can be stayed with a bankruptcy and other tools. In this case I believe interest would stop accruing so the lienholder would be out for 6 months, a year, or possibly longer with no interest accruing. Furthermore, who pays the fees to defend the lien (the county, lien buyer, etc..) and are these permitted to be added to the outstanding amount?
- Foreclosure costs: The tax lien process is very efficient today especially for small amounts. With this ruling it appears every tax lien regardless of the amount must go through and auction process before redemption of the tax lien. This raises the question as to who pays. A typically foreclosure sale can run between 5-15k depending on the state (judicial, non-judicial, etc…) and can take between 60 days and a few years. Will the courts for example allow a 10k fee for foreclosure costs on a lien that might have only been 500 dollars?
Tax lien ruling creates huge problems for Cities/Counties
Just looking at the two questions above, this is the tip of the iceberg. The ruling creates huge problems for counties. For example, if buyers are no longer willing to buy a tax lien, then the county is delayed in getting their money to fund services like Fire, Police, schools, etc… There likely will be some percentage of tax liens that are no longer bought as the risk reward is not there. Furthermore, counties are going to be spending a ton more money on tax liens if they have to foreclose on every single tax lien in order to transfer a deed. This will add considerable time and money. Long and short, the ruling by the supreme court will have enormous implications for counties and cities throughout the country.
Why you should not buy property tax liens going forward
Based on this ruling, I would be hard pressed to even consider buying a tax lien. Let’s assume you bought a tax lien for 2k on a property in Colorado, they don’t pay and interest is accrued. You file for a treasure’s deed after three years. To get a deed, the county will have to initiate a foreclosure auction (takes 6-9 months in Colorado). Let’s assume the best case, you end up getting your funds back + the statutory interest as someone bids out at the foreclosure. In essence you would make 10-12% return on your money each year. Now, let’s consider the downside. This is assuming that the county is going to cover the costs of the foreclosure and can add this amount to the outstanding balance; note, I’m not convinced that courts will allow this, and we will just have to wait and see.
Now, assuming the same scenario above in Colorado, you file for the treasurer’s deed and the county initiates foreclosure. At the same time the borrower declares bankruptcy, so your interest stops accruing. Let’s assume the BK is dismissed, the borrower can then file bankruptcy again, especially in very debtor friendly states. Long and short this whole process drags on for a year or so, now let’s assume you had a 10% return in years one through 3, so 30% over the 3 years, with BK you are now in year 4 with no accrued interest. Now your annual return is about 7.5%, which is the absolute best case. This assumes that the courts allowed all the costs to be included on the tax lien and that the property actually sells for that amount. Let’s now assume the property was a piece of land only worth 50k, the legal fees added up to 60k so you are now left with zero!
The above example, although hypothetical for tax liens is not really hypothetical. We had a loan where we made a 100k mortgage, the borrower bankrupted multiple times in multiple states that tied up the foreclosure for almost 18 months and ultimately cost over 60k in legal fees. The scenario above will happen as a result of this ruling and the tax lien buyers are going to quickly discover the huge downside risk to this investment.
Summary
The tax lien ruling creates far reaching precedents for the entire country. The new process that must be implemented as a result will exponentially raise not only the costs of perfecting a tax lien, but also raises questions of liability and return on investment. Counties are going to be put in a pinch as investors refuse to buy certain liens or possibly any tax liens at all due to the liability. Based on this ruling, I would be hard pressed to even consider buying a tax lien as your upside potential is eliminated and capped at the statutory interest rate while on the flip side your downside risk is huge where you lose your entire investment and possibly worse than that where you are forced to defend against a liability claim. Long and short, be extremely careful and my personal advice would be to not even consider any investment in tax liens until there is more case precedent on liability.
Additional Reading/Resources
- https://www.theusconstitution.org/litigation/tyler-v-hennepin-county/#:~:text=In%20Tyler%20v.,to%20any%20%E2%80%9Ccriminal%20behavior.%E2%80%9D
- https://www.supremecourt.gov/opinions/22pdf/22-166_8n59.pdf
- https://codes.findlaw.com/co/title-39-taxation/co-rev-st-sect-39-12-111.html
- https://www.gunnisoncounty.org/213/Online-Tax-Lien-Sale
- https://www.fairviewlending.com/colorado-hard-money-loans/
- https://www.fairviewlending.com/the-largest-buyer-of-mortgages-predicts-big-changes-to-house-prices/
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Glen Weinberg personally writes these weekly real estate blogs based on his real estate experience as a lender and property owner. I’m not an armchair reporter/writer. We are an actual private lender, lending our own money. We service our own loans and own commercial and residential real estate throughout the country.
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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