The old saying about the only two certainties in life being death and taxes needs to be addressed by bankruptcy practitioners on both sides of the bar. Debtors, creditors and Trustees alike face challenges when it comes to real estate taxes as applied in Illinois. This paper will explore both the historical and current problems, pitfalls and solutions as they apply to Chapter 7 and Chapter 13 bankruptcy cases. 1
The rallying cry of "no taxation without representation" and "give me liberty or give me death" spurred the Revolutionary War on to victory. Out with the King, in with George Washington and the Federal Government. After the euphoria of victory wore off, one assumes that reality set in. The who, what, when, where, how of everyday social services need had to answered. Schools, roads, libraries, police, firemen and forest preserves all had to be paid for.
The Constitution then began to provide for the concept of Home Rule. In it’s most simplistic form, home rule in Illinois means that each county with a chief executive officer elected by the voters and any municipality which has population of more than 25,000 are home rule units.
This breakdown to home rule districts for real estate taxing purposes allows these small units the opportunity to keep real estate tax dollars in the community.
In a Chapter 7 bankruptcy of a homeowner, the debtor’s attorney, the mortgagor’s attorney and the Chapter 7 Trustee all have an analysis to do to determine the impact that unpaid real estate taxes have on the Chapter 7 estate. Under Illinois law, unpaid real estate taxes are a lien against property on which they have been assessed.2 The date to be used is January 1 of the year.3
Illinois Compiled Statutes 35 ILCS 200/21-75 states:
"Lien for taxes. The taxes upon property, together with all penalties, interests and costs that may accrue thereon, shall be a prior first lien on the property, superior to all other liens and encumbrances, from and including the first day of January in the year in which the taxes are levied until the taxes are paid or until the property is sold under this Code."
Both the first lien and time frame addressed by the statute are problematic from a bankruptcy liquidation analysis framework. The taxes are not paid until many months after the January 1 due date and many times assessment/tax bills do not arrive until May. Then the fact that taxes continue to accrue must be taken into account.
If a Chapter 7 bankruptcy is filed on August 30, to properly determine the equity available to the estate, twenty months of real estate taxes must be subtracted from the value of the home. This must be done prior to any deduction for consensual liens.
To further complicate matters, real estate taxes are not personal obligations but are liens against the real estate.4
From the Chapter 7 practitioner’s perspective the suggested analysis to determine if the property has equity for the estate is:
Value of Home
- (sold taxes, but not redeemed)
- (unpaid but not assessed real estate taxes)
- (consensual liens)
- (debtor(s) exemption under homestead)
- (non-consensual liens) (Potential Equity)
The Chapter 7 Trustee would take this analysis one step further by adding costs of sale at the bottom of the analysis.
If the property has no equity for the estate under Chapter 7, the property will be abandoned back to the debtor. The problem is, if the unpaid taxes are not paid timely, the Chapter 7 debtor can still lose the home under the Illinois real estate tax sale provisions. Since the real estate taxes were never a personal obligation of the debtor, the debt never existed to be discharged. The unpaid taxes continue to accrue as a first lien above all others against the land until paid.
The primary purpose of tax sale provisions of the property tax code is to coerce tax delinquent property owners to pay their taxes. Should Chapter 7 debtors wish to keep their real estate, then they must pay the delinquent taxes, before the annual tax sale held on a county to county basis. If the Chapter 7 debtor is unable to do that, then the redemption procedures under 35 ILCS 200/21-345 apply. The debtor has a right to redeem the property. 35 ILCS 200/21-350 gives the redemption period as two years from the date of sale. These dates are critical. Once the expiration of time for redeeming property taxes has lapsed and the property is to be sold at a tax foreclosure sale, the taxpayer’s Chapter 13 bankruptcy estate has no remaining interest in the property, such as would be protected by automatic stay. 5
If, however, the first mortgage holder redeems those taxes prior to the sale, a Chapter 13 debtor can take 24 to 36 months to redeem them from the mortgage holder. This is usually done by the lender prepaying out of the escrow, if one is established. Should there be no escrow for taxes, the general mortgage provision allowing lenders to pay sums necessary to protect their interests comes into play. It is therefore possible for a Chapter 7 debtor to be current on principal and interest payments but still be forced to face a foreclosure action due to unpaid but assessed real estate taxes. The debtor by not paying the real estate taxes has allowed a superior lien to the first mortgage to attach.
The Chapter 13 debtor must go through similar analysis as the Chapter 7 debtor to determine what percentage must be paid back to unsecured creditors. The test that unsecured creditors in Chapter 13 must receive what they would have received in a Chapter 7 still applies. What becomes problematic is Chapter 13 debtors who do not have escrows set up with their mortgage companies and new tax in subsequent years are not paid. Even if the Chapter 13 debtor is current on all mortgage payments and Chapter 13 payments, the failure to pay real estate taxes post confirmation could result in the real estate being lost and the plan failing.
While in a Chapter 13, it is possible to put assessed but unpaid real estate taxes into your plan of reorganization. The County Treasurer must be listed correctly; the years to redeem and the amount due should be on Schedule D as a secured priority claim.
This class under the absolute priority rule would be paid after 13 administrative claims. It is important to make sure that the particular County Treasurer puts in a proof of claim. Without the proper claim, the taxes will not be paid.
Unpaid real estate taxes continue throughout any bankruptcy to be a serious threat to real property. The wise practitioner in the bankruptcy area, on any side, should make a careful analysis on a case-by-case basis to determine exposure on the issue of unpaid real estate taxes. The law allows ample time for redemption, but failing to act in a timely manner can be catastrophic. A properly executed tax deed deprives all of the original parties of all of their respective rights to the real estate. With careful planning and money, this result can be avoided.
1 This analysis is done under the current bankruptcy code. Should Congress in it’s infinite wisdom choose to enact reform legislation, all bets are off and the reader is on his/her own. Should in the next twelve (12) months this reform become law, re-evaluation of these maybe necessary.
2 In re Casper, Bkrtcy S.D. IL 1993, 156 B.R. 794
3 Griffin v. Gould, App. 1st Dist. 1979, 28 Ill. Dec. 925, 72 Ill. App. 3d 747, 391 N.E. 2d 124 In re OBT Partners, Bkrtcy N.D. 1997, 214 B.R. 863
4 Chodl v. Chodl, App. 2d Dist. 1976, 37 Ill. App. 3d 52, 344 NE 2d 711
5 Jackson v. Midwest Partnership, N.D. Ill. 1994, 176 B.R. 156
Susan G. Castagnoli is a sole practitioner in Naperville. Her practice concentrates in bankruptcy and family matters. She received her Undergraduate Degree from Monmonth College and her Law Degree from Northern Illinois University.