Addressing Property Taxes In Bankruptcy

Property taxes are treated as priority debt in a bankruptcy, but very rarely cause a problem for clients filing a Chapter 7 or Chapter 13 bankruptcy, so long as action is taken before the taxing authority takes aggressive steps to  collect on the debt.

Most clients easily grasp the concept of secured debt vs. unsecured debt. Secured debt, essentially, is debt that is secured by an interest in property. Your car would be a good example. If you stop paying, the creditor has a right to repossess the property—their loan is secured by your vehicle. Unsecured creditors have no such rights based on your contract with them, though they can use the court system to get to your property. Priority debt works a little differently.

The bankruptcy code distinguishes certain types of debt as priority debt. The theory is that this type of debt deserves a higher treatment than credit card debt or medical bills. Examples of priority debt are spousal or child support, and tax debt. In a Chapter 13 bankruptcy, all priority debt must be re-paid over the course of the plan in bankruptcy. In a Chapter 7, priority debt survives the bankruptcy; it doesn’t keep you from filing, but you will still have to answer to those creditors after your discharge.

Property taxes that come due within one year of filing are considered priority debt. Additionally, for as long as the client owns the property the debt is associated with, that debt is priority debt and secured by the property. There is good news, though. Whether in a Chapter 7 or a Chapter 13, if the client relinquishes the property, it will typically go through the foreclosure process.

As part of the foreclosure process, back taxes are typically paid by the foreclosing bank, in order to give the new buyer clear title. So, for most clients, it makes sense to delay paying the property tax, give up the property in bankruptcy, and hope the foreclosing bank or new buyer will pay them as part of delivering clear title to the new buyer. All of this can typically be accomplished before the taxing authority takes more serious steps against the client to try to collect on the debt.