States with Loopholes That Allow Home Equity Theft

Ordinarily, the former owner is entitled to claim surplus proceeds from a tax foreclosure sale. And, in many cases, the former owner has the right to repurchase the property after foreclosure by paying the tax debt plus interest and costs.¹ However, for each tax-foreclosed property, the municipality is empowered to either sell the property or keep it for public use. In the latter case, there is no mechanism to determine and transfer the property’s equity value.² When the government takes property this way, it is an undisguised end run around the Constitution's just compensation requirements.

Under Chapter 7 of the California Revenue and Tax Code, tax delinquent properties are sold at public auction after a three- or five-year redemption period.³ Proceeds from the auction are first applied to the encumbering debt before being made available to the former owner and existing lienholders.⁴ 

However, there is a substantial loophole that allows certain purchasers to skip the auction and simply pay the amount of the tax debt—generating no proceeds from a market sale and dissolving the equity interest in the property. Chapter 8 of the tax code empowers taxing agencies to transfer tax delinquent property to a government entity for any public use or a public interest organization for the purpose of low-income housing.⁵ Neither is required to pay just compensation to the former owner, and no surplus proceeds are generated. While ensuring access to low-income housing may be a laudable goal, the government cannot circumvent its obligation to provide just compensation to former property owners at the expense of pursuing its goals. 

Tax liens in Iowa are sold to the bidder who offers to take the smallest portion of the delinquent property. In theory, this procedure preserves equity by ensuring that the debt is satisfied by taking the least amount of property possible. However, because systems like this can result in winning bids that exceed the amount of the tax debt, interest, and fees, the outcome is often as bad as a home equity theft state. For example, an investor who wins a tax lien by bidding to take 50% of a $100,000 property to satisfy a $10,000 tax debt would take a $40,000 windfall from the owner’s equity.

Tax liens in Louisiana are sold to the bidder who offers to take the smallest portion of the delinquent property. In theory, this procedure preserves equity by ensuring that the debt is satisfied by taking the least amount of property possible. However, because systems like this can result in winning bids that exceed the amount of the tax debt, interest, and fees, the outcome is often as bad as a home equity theft state. For example, an investor who wins a tax lien by bidding to take 50% of a $100,000 property to satisfy a $10,000 tax debt would take a $40,000 windfall from the owner’s equity.

In Nevada, the former owner is usually entitled to claim excess proceeds from a tax sale. However, there are two loopholes that allow the government to unconstitutionally seize the equity value of tax-indebted property. First, if any local government or the Nevada System of Higher Education wishes to acquire tax-deeded property for a public purpose, it can purchase the property for the amount of delinquent taxes, penalties, interest, and costs.⁸ Second, if the property is on Indian land, the tribe can acquire the property for no consideration at all.⁹ 

These loopholes are unconstitutional because they necessarily mean that no surplus equity is generated and the former owner is left with nothing regardless of the difference between the tax debt and the value of the property. This is a violation of the Constitution's just compensation requirements.

In Rhode Island, the owner's equity is protected through a procedure where investors bid down on the percentage ownership they will take of the property in exchange for paying a tax lien. For example, an investor may offer to take a 1% interest in the property in exchange for paying the property taxes and taking a right to collect interest on those taxes.

This system is unnecessarily complicated, but provides at least some protection for equity. However, the statute allows a taxing municipality to take a tax deed for itself for public use, without a bid-down auction and without any protection for the owner's right to just compensation.¹³

In Texas, the former owner normally has the right to claim excess proceeds from a tax sale.¹⁴ However, the government may choose to sell tax-foreclosed property at a discount if it would be consistent with a municipality's redevelopment plans or affordable housing policy.¹⁵ If municipalities exercise this option, these properties will be sold for less than their market value.

In contrast with states like California, where there is no sale, in Texas surplus proceeds must still be returned to the former owner. However, municipalities would be taking some or all of the equity because they are selling property at a discount. To satisfy the Constitution, the government must instead sell the property at a publicly advertised auction, which has the best chance of obtaining a fair market price and preserving the most amount of equity.

In Montana, surplus proceeds from a tax sale of residential property are returned to the former owner.¹⁶ However, this protection is explicitly limited to residential property only.¹⁷ Owners of commercial and other types of property maintain an equal right to just compensation for lost equity. Unfortunately, by allowing the equity built into these properties to be seized by the government or private lienholders, Montana law runs afoul of the Fifth Amendment. Montana is the only state to fully protect residential property equity while leaving other types of property equity unprotected.