Only a minority of states practice home equity theft. Most states recognize that when the government forecloses on a property due to failure to pay taxes, it can’t take more than it’s owed. Any surplus equity in a tax foreclosure properly belongs to the former owner of the property.
Still, even states that strongly protect property rights sometimes have loopholes or poorly designed procedures that threaten former owners’ equity. While tax foreclosure statutes tend to be complex, constitutional flaws can typically be addressed by relatively minor adjustments to language and procedures.
Below are two examples of the best state procedures. Wisconsin is a “tax deed” state, in which a county keeps ownership over a lien for delinquent taxes until the property is foreclosed upon and then sold or converted to public use. Florida is a “tax lien” state, in which the government sells the lien to a third party, who then enforces the lien and forecloses when warranted. Both states strongly protect equity.
In Wisconsin, real property taxes are due annually on January 31.1 If taxes remain unpaid by September 1, the county treasurer issues a “tax certificate” listing all delinquent parcels.2 The tax certificate is effectively a lien,3 and its issuance generally commences a two-year redemption period.4 The treasurer must mail a notice to all property owners within 90 days of the issuance of the tax certificate.5 If this notice is mailed late, the redemption period begins on the date of the mailing.6 The county treasurer must also publish additional notice between six and 10 months before the expiration of the redemption period.7
When the redemption period expires, a county has three options for foreclosing on the property. Each option protects the owner’s equity interest, though one is subject to a potential loophole.
In the first option, the county may use the same procedures as for a private mortgage foreclosure.8 This is an ideal way to handle tax liens, since the laws of private mortgage foreclosure in virtually all states protect the equity of all interested parties.9 States using this procedure should review deadlines for requiring sale of the property so that the former owner is compensated in a reasonable period of time.
In the second option, the county may proceed with a tax lien foreclosure action in rem (to recover funds from the property instead of suing the owner).10 Like a mortgage foreclosure, this is a judicial procedure. Unlike a mortgage foreclosure, however, the refund of surplus proceeds to the former owner upon the sale of the property does not happen automatically. Instead, the onus is on the owner to make a claim in court for the surplus proceeds within two years of the foreclosure judgment.11 This procedure might be appropriate in cases where, for instance, the former owner cannot be found. States using this procedure should review requirements on the former owner for undue burdens and for appropriate assessments of court and administrative fees.
In the third option, the county may apply for a tax deed to take ownership of the property through an administrative proceeding (not a judicial one). Additional notice to the owner is required before a tax deed may issue,12 and upon issuance, the county must also notify the owner of her entitlement to the surplus proceeds from a future sale.13 The county typically sells the property14 and then returns surplus proceeds (after costs and fees) to the former owner.15 Here, Wisconsin puts the onus on the government to identify, locate, and reimburse the owner.16
While the additional notice and the requirement that the government locate and reimburse the former owner make this procedure one of the stronger options for tax deed sales, it fails to provide a clear path to reimbursement of the former owner in cases where the government does not sell the tax-deeded property.17
The law here authorizes but does not require a sale, considering that the government could keep the property by dedicating it to public use.18 In such cases, the law provides no clear mechanism for the former owner to claim surplus equity. Arguably, the owner could bring a suit for inverse condemnation, but it is unclear how such an action would fare in court. Wisconsin and other states that permit the government to retain ownership of such property should strengthen the protection of property rights by providing a statutory right to the surplus equity of tax-deeded property left unsold or dedicated to public use.
Finally, the sale of tax-deeded property under the third option need not be by public auction.19 While auctions still must be well regulated to ensure a fair sale price, they tend to be better at protecting equity than private sales, which can have less price competition. This is another area where Wisconsin could improve its tax foreclosure system. Even so, Wisconsin is a leading tax deed state.
Florida is a strong example of equity protection among tax lien states.
In tax lien states, the government does not enforce the lien on tax-delinquent property. Instead, it sells the lien—and the power of enforcement—to a private investor. The lienholder may try to collect delinquent taxes, plus interest, from the property owner. In most tax lien states, if the property is not redeemed in time, the lienholder may foreclose and get full title to the property.
That presents a significant problem because tax liens typically sell at prices far below the actual market value of the home. Many states “fix” the sale price of a tax lien at the amount of debt owed on the property. For example, if the property is worth $100,000 and unpaid taxes are $10,000, the sale price is fixed at $10,000. As a result, the sale generates no surplus, and there is no way to protect the owner’s equity, which means a total failure to protect the equity of the owner.
Potentially owning a property at such a discount is attractive to investors. So, how do investors compete for it when the sale price is fixed? Instead of bidding up the sale price, auction participants “bid down” on the lowest interest rate that they will charge the owner (as in New Jersey20 and other states).
A different “bid down” model, as in Iowa, still fixes the sale price at the amount of delinquency, but only on a portion of the property; the government sells the lien to the bidder who agrees to take the smallest portion of the property.21 In theory, competitive bidding should result in the sale of a tax lien that covers little more than the value of the portion of the property that equals the amount of the tax delinquency.
Using a more familiar auction procedure, in which participants bid up on what they will pay for the lien (such as in Colorado)22, still does not typically yield the market value of the property. This is because after the auction winner buys the tax lien, the owner can still redeem the property. As a result, buying the lien can be a risky investment, which drives the lien price down and leaves the former owner with an insufficient surplus.
The best procedure for tax lien states, however, is one which forces a resale of the property after the lien is foreclosed, so that the property is sold at a market price. That is the system in Florida. Governments in Florida first auction tax liens at a price fixed by the amount of delinquency, like in several other states, using a bid-down auction based on interest rate.23 After a two-year redemption period, the lienholder may apply for a tax deed.24 Then, unlike in most other states, the tax deed does not automatically go to the lienholder. Rather, the application for a tax deed triggers a new sale, in which the property is sold to the highest bidder.25 Surplus proceeds are returned to the former owner.26
Thus, Florida maximizes value for the tax-delinquent property owner in two ways. The initial tax lien sale tends to push down the interest rate on the lien, making redemption less expensive and leaving more equity in the property. Then, the property sale yields a market price, generating surplus proceeds that better match the owner’s remaining equity than in other models.
Tax foreclosure laws are complex, and they vary significantly from state to state. Even so, lawmakers can take simple steps to review and amend statutory procedures to protect property owners’ equity. The Wisconsin and Florida models demonstrate leading options for this protection.