What is a tax sale?
In the United States, anyone who owns property must pay some sort of real estate tax to the government. The taxes that are collected pay for public services, such as, hospitals, schools, law enforcement, road construction, parks and playgrounds. But, what happens if a property owner stops paying taxes? How does the county government recover this money to fund all of these services?
If a property owner does not pay the required taxes on a property, the county will offer the property up for sale at an auction as a “tax sale” to generate the lost tax income. There are two types of tax sales – tax lien sales and tax deed sales. In tax lien sales, the county government sells their right to the tax lien on the real estate property, allowing the buyer to bid on the tax debt for a favorable return on investment. In tax deed sales, the county government sells full ownership and possession rights of the property to the investor. Both can result in a flexible and secure investment with minimal market risk.
What is a tax lien?
A legal claim by a government entity against a non-compliant taxpayer’s assets. Tax liens are a last resort to force an individual or business to pay back taxes. To get rid of a lien, the taxpayer must pay what he or she owes, get the debt dismissed in bankruptcy court or reach an offer in compromise with the tax authorities. Federal and state governments may place tax liens for unpaid federal or state income taxes, while local governments may place tax liens for unpaid local income or property taxes.
The tax lien is meant to bring notice to the homeowner that the taxes are delinquent and the process has reached the final stage before the County moves to foreclose on the property.
What is a tax lien certificate?
A certificate of claim against property that has a lien placed upon it as a result of unpaid property taxes. Tax lien certificates are generally sold to investors by most counties and municipalities in the United States through an auction process. Subsequent to a winning bid made by an investor for a specific tax lien certificate, a lien is placed on the property and a certificate issued to the investor detailing the outstanding taxes and penalties on the property. The tax lien certificate therefore enables the investor to collect unpaid taxes plus the prevailing rate of interest applicable to such certificates, which can range from 8 to more than 30%, depending on the jurisdiction. The term of tax lien certificates typically ranges from one to three years.
Thanks to the high state-mandated rates of interest, tax lien certificates may offer rates of return that are substantially higher than those offered by other investments. As well, since tax liens generally have precedence over other liens such as mortgages, should the property owner fail to pay the back taxes, the investor could potentially acquire the property for pennies on the dollar. However, this is a rare occurrence, since the vast majority of tax liens are redeemed well before the property goes to foreclosure. Negative aspects of tax lien certificates include the requirement for the investor to pay for the tax lien certificate in full within a very short period of time, usually one to three days. These certificates are also highly illiquid, since there is no secondary trading market for them. Investors in tax lien certificates also have to undertake significant “due diligence” and research to ensure that the underlying properties have value and are not worthless.
How does a tax lien auction work?
A tax lien auction is the sale, conducted by a governmental agency, of tax liens for delinquent taxes on real estate. It is one of two methodologies used by governmental agencies to collect delinquent taxes owed on real estate, the other being the tax deed sale.
In a tax lien auction, the lien (for delinquent taxes, accrued interest, and costs associated with the sale) is offered to prospective investors at public auction. Traditionally, auctions were held in person; however, Internet-based auctions (especially within large counties having numerous liens) have grown in popularity as this method allows for bidders from outside the area to participate.
In the event that more than one investor seeks the same lien, the winner will be determined by one of five methods (each state is different):
- Bid Down the Interest. Under this method, the stated rate of return offered by the government is the maximum rate of return allowed. However, investors can accept lower rates of return, including zero percent in some cases (though this is rare in practice). The investor accepting the lowest rate of return is the winner. In the event more than one investor will accept the same lower rate, a random or rotational method (see below) will be used to break ties. (Florida and Arizona use this method)
- Premium. Under this method, the investor willing to pay the highest “premium” (or excess above the lien amount) will be the winner. The premium may or may not earn interest, and may or may not be paid back to the investor upon redemption of the lien. (Colorado uses this method)
- Random Selection. Under this method, a bidder will be randomly selected from those offering a bid. Usually a computer is used to make the selection, but in smaller jurisdictions more rudimentary methods may be used. Nevada uses Random selection since it is supposed to be the first buyer but it is hard to determine who was the first person to the sale.
- Rotational Selection. Under this method, the first lien offered for sale will be offered to the investor holding bidder number one, who has the right of first refusal. If bidder number one refuses the lien, bidder number two may then bid. However, bidder number one will not be offered another lien until his number comes up again in the rotation. The next lien will go to the next number in line. Under this method, the investor has virtually no control over which liens s/he will obtain in the bidding, except to take or refuse what is offered.
- Bid Down the Ownership. Used in Iowa and few other states, the investor willing to purchase the lien for the lowest percent of encumbrance on the property will be awarded the lien. For example, a bidder may agree to take a lien on only 95% of the property. If the lien is not redeemed, the investor would only receive 95% ownership of the property with the remaining 5% owned by the original owner. In practice, few investors will bid on liens for less than full right to the property or sale proceeds. Therefore, with multiple owners bidding on 100% encumbrance, the process then generally reverts to the random selection.
Liens not sold at auction are considered “struck” (or sold) to the entity (usually the county) conducting the auction. Some states allow “over the counter” purchases of liens not sold at auction.
The auction itself is like any other, depending on the state format described above.
What is a tax deed?
A legal document that grants ownership of a property to a government body when the property owner does not pay the taxes due on the property. A tax deed gives the government the authority to sell the property to collect the delinquent taxes and transfer the property to the purchaser. Such sales are called “tax deed sales” and are usually held at auctions where the minimum bid is the amount of back taxes and fees owed.
In order to acquire a tax deed, the taxing authority, often a county government, must go through a series of legal steps, including notifying the property owner, applying for a tax deed, posting a notice at the property and posting a public notice. The exact steps that must be taken will vary in accordance with local and municipal laws.
How does a tax deed auction work?
In some jurisdictions, the property itself is sold at the tax sale auction. After the sale is completed, the taxing authority provides the tax sale purchaser with a deed to the property. The purchaser becomes the new owner of the property, either immediately following the sale or after a redemption period expires. Because the purchaser typically receives a tax deed to the property, the tax sale procedure in such states is often referred to as a “tax deed” sale.
The proceeds from the sale are used to satisfy the outstanding tax bill and pay any costs of the sale to the municipality. Any surplus above the tax obligation and costs is paid to the former owner or to junior recorded lien holders if required by law.
After I purchase a property, should I make repairs?
It always depends on the condition of the property and how much more you have to invest in the property.
Minor repairs before putting the house on the market may lead to a better sales price. Buyers often include a contingency “inspection clause” in the purchase contract which allows them to back out if numerous defects are found. Once the problems are noted, buyers can attempt to negotiate repairs or lowering the price with the seller. Any known problems that are not repaired must be revealed as a material defect. You do not have to repair the problem, only reveal it and the house should be appropriately priced for that defect.
Can anyone buy Tax Deeds?
Yes, if you have the money you can buy the Tax Deed. There are a few exceptions to this rule. In many states, if you live in the same state where you are bidding, your own property taxes must be paid in full before you can bid on other properties and finally, some states require the bidder to have a social security number or federal tax I.D. number.
What if I want to own property?
If your goal is to take property ownership, attend tax deed sales. Less than five percent of all tax lien certificates eventually lead to foreclosure.
Can someone else bid for you at the auction?
It depends on the state. In some states, you can have someone else act as an agent for you and bid on properties. In other states, you must be there in person to bid.
What is the best type of property to bid on?
In most cases, especially for beginners, it is best to bid on residential property, whether it is improved or unimproved. Improved land (e.g., with a house or structure on it) has less risk than unimproved land (vacant land). The latter is more risky, especially in terms of marketability. Commercial property has more risk than residential property and should only be considered by experienced investors. If you are interested in income from the property, then improved land (e.g., with a house you can rent) is your best bet.
Once you get the deed to the property, will you be able to take out a loan on that house?
You generally will need to clear title before you can take out a loan. This is done through ‘Quiet Title’. If there is a legal challenge period following foreclosure, during which the previous owner or other interested party can challenge the tax sale, you will normally have to wait for that period to expire before you can clear title. In California, for example, the legal challenge period is one year; in Arkansas it is two years. Usually counties/states advise that you not make any major improvements to the property during this time period.
By using the quite title method, tax deed properties in California, as an example, can be flipped or resold in as little as 60-90 days after it was purchased at auction by using Quiet Title.