Buyer Risks With Deliquent Property Tax Sales

When acquiring property through a property tax sale, there are risks to the buyer if the property owner becomes a debtor in bankruptcy.  Under the Bankruptcy Code a transfer might be avoided if the debtor was insolvent (or becomes insolvent due to the transfer) and received less than reasonably equivalent value for the property.  If that transfer took place within the look back period (either 2 or 4 years depending on the bankruptcy filed, Chapter 7, 11 or 13) and the sale price was not “reasonably equivalent value” for the property, then the transaction might be challenged as a fraudulent transfer.

The U.S. Supreme Court in 1996 held that in a foreclosure sale, if state law for the foreclosure process was followed, then the price obtained as a result of that foreclosure sale constituted reasonably equivalent value as a matter of law. However, the court noted that there might be exceptions to the rule in other contexts, such as a forced sale to satisfy tax liens.   

In tax sales where the only reason for the sale was to pay the delinquent property taxes, if there is a significant disconnect between the sale price and the value of the property, and if there was no opportunity for competitive bidding, then it’s an open question whether the sale price will be considered a fair value.  If the sale were to be timely challenged in a subsequent bankruptcy, the court may well decide to avoid the sale as a fraudulent transfer.

If that happens, the bankruptcy court could recover the fraudulent transfer from the initial transferee and even the next transferee who acquired the property from the initial transferee (unless buyer #2 can assert a successful defense as a good faith purchaser).

Bottom line. . . when purchasing properties through forfeiture procedures, such as a property tax sales, that do not include competitive bidding, buyers need to be aware that their liability doesn’t end with the transfer deed.


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