Delinquent Property Taxes: Beware The Risk Of Tax Deeds

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...