Property owners received new protection for their equity from a unanimous Supreme Court decision in the Tyler v. Hennepin Countycase in May. The decision affirms that owners must be reimbursed for any remaining equity after a property seizure to pay tax debts. The decision is likely to trigger new legislation in numerous states.
“The most important thing about this decision is that it establishes that the government can’t take more than what it’s owed,” says Christina Martin, a Vancouver, Washington–based attorney with the Pacific Legal Foundation. Martin argued the case before the U.S. Supreme Court on behalf of her client, Geraldine Tyler.
Private property owners, mortgage lenders, and municipalities will be affected by the decision, which essentially says that debtors have constitutional protection for their property.
In the Tyler case, Hennepin County seized a condo belonging to Geraldine Tyler to collect a $15,000 tax debt. The county sold the condo for $40,000 and kept the remaining $25,000 after paying the tax bill. Tyler sued, claiming that the county’s retention of the $25,000 was unconstitutional. Two courts found in favor of the county, but the Supreme Court unanimously agreed that this action was in violation of the Fifth Amendment’s Takings Clause.
Organizations including AARP, the National Association of Home Builders, the ACLU, the Owners’ Counsel of America, and the Cato Institute filed amicus briefs on behalf of Tyler.
“In the Tyler case, the Minnesota county said that when someone doesn’t pay taxes, they forfeit all of their rights to the property,” says Thomas Berry, a research fellow at the Cato Institute, a libertarian think tank based in Washington, D.C. “The principle applies to any property that generates tax bills. But the Takings Clause in the U.S. Constitution mandates that the government can’t take private property unless it’s for public use, as in eminent domain cases. It also says that if the government takes private property, it must provide just compensation and pay fair market value.”
Unfortunately, legislation still exists in nearly a dozen states that allows governments to keep equity beyond the amount of debt, Martin says. The Pacific Legal Foundation’s End Home Equity Theft project provides updates on legislation and ongoing litigation in cases similar to Tyler. Currently, Alabama, Arizona, Colorado, Illinois, Massachusetts, Minnesota, New Jersey, New York, Oregon, South Dakota, and the District of Columbia allow municipalities to keep all equity from a tax foreclosure, according to the site.
“Over the past seven years, thousands of properties have been taken across the U.S. with more money withheld than [former owners] owe,” Martin says. “It’s usually older people, who are more likely to own without a mortgage, so there’s no escrow account to pay the tax bills. In many of these situations, the owners have physical or mental medical difficulties, which can make them less likely to pay their bills.”
In one case in Washington, D.C., a man with dementia underpaid his taxes by $134 and lost his home because of that minor amount of money, Martin says.
“In commercial real estate, the properties sold in a tax sale are typically abandoned properties or places that have little value, such as an industrial property that would need extensive environmental mitigation,” says Steven Hladik, a partner with Hladik, Onorato & Federman, a Philadelphia-based law firm that handles foreclosures. “But the tax foreclosure process is the same for commercial and residential properties.”
Implications of the Tyler Case
The Supreme Court decision does not eliminate the possibility of too much property being taken in states where legislation allows it, Martin says. The decision means that owners can sue to have the additional funds returned.
“Municipalities are beginning to change their legislation in light of the Tyler decision, but property owners should check with their state’s attorney general and be aware of the laws in their area,” Martin says.
Developers, mortgage lenders, and property owners should closely monitor proposed legislation in states that currently have unconstitutional laws that allow all proceeds from tax foreclosures to be retained, says Hladik.
“It’s best to establish a priority system to pay liens after a foreclosure,” Hladik says. “For example, in Pennsylvania, the proceeds from a sale are used to pay the cost of selling, past due, and current tax bills, municipal liens and transfer taxes first. Then, the rest of the proceeds should be used for a first mortgage, a second mortgage, and any other liens.”
The Tyler decision is unlikely to have a widespread impact on mortgage lenders, says Rick Sharga, a foreclosure and mortgage expert and CEO of CJ Patrick Company, a market intelligence firm geared toward real estate and mortgage companies.
“Normally, if a lender forecloses on a property and there are funds left over after all liens are paid, the proceeds go back to the borrower,” Sharga says. “A tax foreclosure falls outside of the regular foreclosure process and is rare on properties that have equity. If taxes are owed on a property with equity, the lender will typically pay the taxes and recoup that money from the foreclosure sale.”
Many mortgage lenders require taxes and insurance to be paid through an escrow account, so the lender can be certain those bills are paid, he says.
Whereas Martin says that extra funds returned to owners after payment of a tax bill could be used to pay off the mortgage or other liens, Hladik believes that it’s best for all liens to be paid before returning any funds to the former owners, rather than rely on them to repay all debt on a property they no longer possess.
In some states, private investors purchase the right to collect tax debt with interest on property that’s seized in a foreclosure. Those investors could be held liable alongside the government in any lawsuit for constitutional violations, Martin says.
Lenders, developers, and property owners should be a voice as new legislation is proposed in the aftermath of the Tyler decision, Hladik says.
“The decision is clearly a win for property owners, but now it’s important to enact laws that establish a priority system for lien payments,” he says.
