If behind on property taxes on property that isn’t your home, either Chapter 7 or Chapter 13 may buy you the time to save this property.
For most people who are behind on property taxes on their real estate, that real estate is their home. And they have a mortgage on that real estate. See our last blog post about catching up on your property taxes on your mortgaged home.
But you may own real estate that isn’t your home, on which you are behind on property taxes. This comes up in a number of scenarios. Today we’ll look at mortgaged investment property on which you’ve fallen behind on property taxes.
First Problem—The Unhappy Mortgage Lender
Again, see our last blog post about why mortgage lenders get very concerned when borrowers fall behind on property taxes. What we said there about mortgaged homes applies as well to investment and other types of real estate.
Briefly, being behind on property taxes is virtually always a breach of your agreement with the mortgage lender. That’s because the property tax is “senior” to the mortgage, meaning a property tax foreclosure would wipe out the mortgage lender’s lien on the property. That’s very dangerous for the lender, so it acts aggressively to get you current on the taxes. This may include the lender paying the tax and then coming after you to pay it back. And if you don’t the lender can start its own foreclosure, even if you’re current on the mortgage itself.
Bankruptcy can solve this problem, one of two ways. A Chapter 7 case “discharges” your other debts so that you can afford to bring your property tax current. And if that doesn’t happen fast enough, a Chapter 13 case buys you more time, up to 5 years. Your court-approved payment plan gives you an affordable, flexible, and protected way to accomplish this.
Second Problem—Justifying Keeping the Property
The bankruptcy system has no trouble helping you pay debts related to your home. Other real estate can get trickier.
If you have investment property, you may need to justify that it’s financially sensible to keep that property. Specifically, you’ll likely have to justify spending money to catch up on the taxes.
For example, is the real estate worth more than you owe on it, including the taxes? If so, that more easily justifies paying the taxes to save your equity in the property.
Also, does the investment real estate generate a positive cash flow? If so, that also more easily justifies paying the taxes to preserve this positive cash flow.
If your investment property has negative equity and/or negative cash flow, it’s hard to justify keeping the property.
Why Does the Bankruptcy System Care?
It cares for budgeting and liquidation purposes.
To go through a Chapter 7 case you must pass the “means test.” That essentially requires showing that you don’t have the means to pay a meaningful amount to your general unsecured creditors. And that in turn usually requires showing a detailed budget. That budget includes a list of allowed expenses. Depending on the circumstances (including the equity/cash flow issues touched on above), you may not be able to include expenses on a financially unnecessary or unjustifiable investment property.
Under Chapter 13 case you pay what you can afford to pay to your creditors through a 3-to-5-year payment plan. As under Chapter 7, you have to justify paying property taxes on a property that isn’t your home. If that property is generating income and helping to pay the other creditors, putting money into that property to pay its taxes is more defensible. If the property is a cash drain justifying putting “good money after bad” into it would be hard to defend.
As for the liquidation issue, in a Chapter 7 case the bankruptcy trustee can liquidate anything that isn’t protected. The protection is mostly in the form of exemptions—property you’re allowed to keep. The Chapter 7 trustee will be inclined to take and liquidate your investment property if it will generate any cash for your other creditors.
Chapter 13 provides a way for you to protect assets you could otherwise lose in a Chapter 7 case. Essentially you pay more into your payment plan to cover the amount of money would have gone to your creditors in a liquidation of your investment property. That may be feasible, depending on your cash flow and on the liquidation value of that property.
Notice that there are some potential Catch-22s when dealing with investment real estate on which you owe property taxes. For example, having equity in the property makes it more prone to liquidation under Chapter 7, but having no equity makes keeping it and curing the taxes harder to justify. Under Chapter 13, a positive cash flow from the investment is important to justify catching up on the taxes. But there’s a good chance you don’t currently have a positive cash flow but rather are just expecting that to happen when certain things fall into place.
So figuring out how to deal with an investment property with owed taxes involves some careful financial and legal judgment calls. This is exactly the kind of situation you need the good counsel of savvy and conscientious bankruptcy lawyer.