Many states protect equity through the foreclosure process. But ten states leave open exceptions or loopholes through which government or private entities can still seize equity. There are three types of loopholes or exceptions: 1) the government allows equity to be taken for a particular public use, 2) certain types of property are left unprotected, or 3) a procedural defect in the foreclosure system allows equity to be taken under certain circumstances.
Taken for Public Use
Some states protect the former owner's equity value through foreclosure, but leave open the door for government entities or certain private parties to take tax delinquent property for public use. Under this loophole, the surplus due to the former owner is heavily reduced or even eliminated altogether. There should be no special treatment for tax delinquent property just because the government wants to keep it for its own ends. The Constitution requires just compensation any time someone's equity is taken for public use.
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.
In Idaho, the former owner typically has the right to claim surplus proceeds from a tax sale of his property.6 However, a taxing county may choose to give the land to any federal or Idaho state entity.7 If such a gift is made, no sale takes place, and no surplus proceeds are available to protect the former owner's equity interest. There is no mechanism in place to ensure just compensation is paid for public use.
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 Ohio, state law generally protects the equity of tax debtors by making surplus proceeds of a foreclosure sale available to be claimed by the former owner.10 But the rules change when a government agency, such as a county land bank, requests tax delinquent property for public uses. The state's tax foreclosure regulations allow a transfer without sale to certain government organizations who take the property free and clear of any obligation to return excess equity value.11
When this loophole is applied, property owners also receive an abbreviated redemption period reducing the amount of time they might be able to preserve their equity prior to final foreclosure.12 Tax delinquent property should not be treated differently just because the government wants to keep it for its own ends. The Constitution requires just compensation any time someone's equity is taken for public use.
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.
Property Left Unprotected
In one state, residential property is protected, while other types of property are subject to equity theft.
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.
In Wisconsin, former owners are entitled to the surplus proceeds following a sale of tax-deeded property at auction.18 However, the law contains a potential loophole because it does not expressly require the government to sell tax-deeded property. Rather, surplus proceeds are due to the former owner only if it decides to sell the property. Otherwise, the government can use the property for any purpose without providing just compensation to the former owner.
The extent of the home equity theft allowed by this system depends entirely on whether localities decide to sell tax-deeded property and how courts interpret the statute. Property owners should not have to rely on bureaucratic goodwill or municipal decision making before they are entitled to receive the compensation to which they are constitutionally entitled. Rather, the statute should expressly force the resale of the foreclosed property and a return of the surplus proceeds to the former owner.