Investing Basics

An Intro to Tax Auction Investing

Learn the in and outs of buying property via tax auctions across the nation.

Let's Get Down to (Basic) Brass Tax... Get it?

If you haven’t purchased a tax deed or lien before, start here. If you have, feel free to poke around in the more in-depth sections below to find what you’re looking for…

So what is a tax lien/tax deed property sale (i.e. How the heck does this thing work)?

In the United States, anyone who owns property must pay some sort of real estate tax to the government (these are called “property taxes”). The taxes that are collected pay for public services – think hospitals, schools, law enforcement, road construction, parks and playgrounds. Typically, the owner will be expected to pay these taxes every year, but what happens if he or she stops paying taxes? What happens to the property? How does the county government recover this money to fund these services?

If a property owner does not pay the required taxes on a property within the required time frame, the property will become “tax delinquent”, which basically means it has started down a path that will eventually lead to tax lien and then tax foreclosure (i.e. – your property will be seized and repossessed by the county).

How long can a property can go “tax delinquent” before it is seized by the county? It all depends on the state.  In California, for example, the property must be delinquent for four years (more details on this in the “How Each State Works” section). In every state in the U.S., there is a set date during the year when these properties will become seized by the county – think using a net to capture them all at once, rather than cherry picking throughout the entire year. In some states, the county will wait for 2 years, others will wait for 5 years, but none of them will wait forever.

The county will then offer the property up for sale at an auction as a “tax sale” to recover those lost dollars from the property owner’s lack of payment. Auction dates and times change not only state-by-state, but even county-by-county, so investors must time their purchases accordingly depending on where exactly they would like to invest. Sales can be as often as every two weeks or as minimal as once a year.

There are two types of these “tax sales” which each county administers – either tax lien sales or 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. See the next section to dive deeper into these “tax sale” types.

How Each State Differs ... or Shall We Say Defers?
Every state has a unique set of rules and regulations when it comes to not only the time frame required to pay taxes current and delinquent taxes as we mentioned above, but also how the foreclosure process is handled and how each county will try to re-gain its lost tax revenue (i.e. through either of those two types of tax sales we talked about above). Depending on which state(s) you focus on, there are some basic rules you need to understand about how the process works…

SIDE NOTE: Almost every state has SOME kind of variation in how they handle the various aspects of their process, regardless of which kind of tax sales they have – so whichever state you decide to work in, be sure to take your time and do your homework on that particular state and county.

Generally speaking, a county’s primary concern is to generate enough revenue from each property to make up for their lost property tax revenue associated with the specific property (whatever that number happens to be). Surprisingly, the actual “market value” of each property is mostly irrelevant to the county. Even if a property could feasibly sell for $500,000 (market value) – the county’s intent is to generate enough funds to restore the amount of unpaid taxes they were owed from the delinquent property owner. So, for example, if a property worth $500,000 only had $10,000 of delinquent taxes at the time of foreclosure, this $10,000 number is usually the county’s only real concern (and most often they will even start the opening bid amount during the tax sale auction at this price).The supposed $500,000 “market value” holds little relevance to the county – and this is where the real opportunity comes from at a tax sale.

A lot of properties can be bought for ridiculously low prices at a tax sale. Why? Because you’re not dealing with a normal property owner who cares about getting full market value, you’re dealing with the local government interested in collecting only the delinquent taxes and penalties, if any. Contrary to popular belief, it’s not the government’s goal to get rich off every property they sell. They just want to get these properties off their books and in return, they want the money they were owed in the first place (with the hope that these properties will end up in the hands of someone who will keep the property taxes paid current and they don’t have to deal with it again). So how does a state choose? Well, they only really have two options to choose from and most are pre-determined from years ago…

Explaining Tax Deeds & Liens (What Goes Into Each One?)

Tax Liens:

A tax lien, by definition, is “a legal claim by a government entity against a noncompliant taxpayer’s assets.” They are a last resort to force an individual or business to pay back taxes, whether those are property taxes or some other asset 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. That’s where the property tax liens we’ve been talking about come into play.

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 (think of a million notices left on your doorstep to pay your taxes – this the final straw from the county’s eyes).

What happens when they foreclose on the property because the owner doesn’t pay his/her?

There are certain steps which county’s must follow to complete the foreclosure process, one of which is generating a tax lien certificate, which is then generally sold to investors by most counties and municipalities in the United States through an auction process in order to earn their lost money back (is it starting to make sense now?).

Following a winning bid made by an investor for a specific property’s lien certificate, a lien is actually then placed on the property and the certificate is then issued to the investor, which details 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.

Let’s drill in that point one more time – when someone purchases one of these tax lien certificates, they are not buying an ownership interest to the property. Instead, they are buying a lien on the property. As the owner of a tax lien certificate (aka – tax lien), the delinquent property owner still owns the property. However, the lien holder is entitled to repayment for the amount of the tax lien certificate plus interest and penalties.

SIDE NOTE: It’s important as the investor to know that the tax lien holder is in first position ahead of any other liens recorded against the property, which includes any mortgage or deed of trust. If the property owner fails to pay off this lien within the “redemption period” specified by their state, the lien holder has the right (but not the obligation) to foreclose on the property and take ownership. In most cases, if the lien holder does not move forward with foreclosure within the period of time specified by their state, the lien will be forfeited and the lien holder will lose their investment. Once again this illustrates how important it is to know the requirements and process within a certain county.

Every state has a different set of rules regarding the redemption period, the amount of interest that can be charged, the foreclosure proceedings, and several other aspects of the process. When purchasing tax liens your primary objective should be the interest and penalty and not acquiring the property through foreclosure. Generally speaking, once you understand how it works in one state, you’ll be able to learn how other states work relatively quickly (because there are simple variations to the same basic process).

Tax Deeds:

A tax deed, by definition, is 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.

Tax Deeds vs. Tax Liens (A Pros and Cons List)

If you’re trying to decide whether to invest in tax liens or tax deeds, it comes down to what your capabilities and goals are as an investor. Asking a few simple questions can usually decide which path you will start with. Most investors begin investing in their own county or a nearby county and this usually decides for you.

If you’re looking for a simple investment with a very strong return, (much greater than anything you would receive from a conventional investment), tax liens are a great way to do it. For example, New Jersey offers a maximum rate of 18%, Arizona offers a maximum rate of 16% and Iowa offers a guaranteed 2% per month (i.e. – 24% return annually). There are several other states that have similar returns and often small considerations that will allow for great returns once you learn that specific process.If you want to purchase real estate tax deeds can be a great way to do this. Many that become involved in this process do so with the intention of buying real estate.  Once involved in tax deeds you will see purchases far below the current market value of the property which affords great profit in flipping the property or a buy/hold/rent scenario.

Looking at Tax Liens:

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. In addition 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 (since the investor does not own the property if they are only purchasing the lien to the property). 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.

Analyzing Tax Deeds:

Similar to tax liens, the county’s primary interest is to recoup the unpaid property taxes on each property. Once a tax deed has been sold to an investor, the prior owner cannot come back and reclaim their property. When you purchase a tax deed – you own the property free and clear. All mortgages and/or trust deeds are wiped out by the tax foreclosure process.The disadvantage over tax liens is that an investor can get involved in tax liens for very little investment while tax deeds, since you are purchasing the property at auction the bidding can go much higher. For example, a property worth $500,000 could easily see the bidding go as high as $250,000.

How Does The Tax Sale Auction Actually Work?

A tax lien auction is the sale, conducted by a governmental agency, of tax liens for delinquent taxes on real estate. A tax deed auction is the sale, conducted by a governmental agency, of tax deeds for delinquent taxes on real estate.

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. Same goes for tax deeds. Traditionally, auctions were held in person; however, Internet-based auctions (especially within large counties having numerous liens/deeds) 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 or deed, the winner will be determined by one of five methods (each state is different):

1. 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)

2. 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)

3. 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.

4. 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.

5. 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 and deeds 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.

How Redeemable Deeds Work

If you can envision Tax Liens on one end of the spectrum and Tax Deeds on the other, redeemable deeds live somewhere between the two because they share some similarities with both sets of rules (and many of these similarities depend on which state they are being sold in).

When you purchase a redeemable, you are literally purchasing a deed to the property (just like a tax deed). However, a redeemable deed is also subject to a redemption period (just like a tax lien), which adds a bit of complexity to the process. For a set period of time after the redeemable deed is sold, the prior owner has the right to “redeem the deed” and purchase the property back from the investor. In order to purchase the property back, the prior owner has to pay the full amount that was paid for the property at the tax sale along with some costly fees and penalties (regardless of how much time has accrued during the redemption period).If the prior owner does not redeem their deed within the specified redemption period, they will lose all their redemption rights and the investor can rest easy knowing that they are the official owner of record.

Considerations When Investing in Tax Liens & Tax Deeds

Now that you are (hopefully) beginning to understand the process of how tax liens and tax deeds work, along with some very good, legitimate reasons why you might want to consider investing in them.  You should know that many potential investors that get involved do so with only the knowledge described up until this point.  The considerations are like every real estate investment or any investment for that matter.  When you buy a home do you simply purchase the first one you investigate? Of course not, and the same applies to purchasing a tax deed or lien.

Many investors attend auctions and take the time to learn how this whole process works, but it’s not because they like to buy tax liens and tax deeds. They find it relevant only because the process of tax foreclosure works hand-in-hand with their primary investing strategy. The goal is to buy tax delinquent properties and profit.

There are a few primary reasons why investors lose interest in tax lien and tax deed investing:

Tax Foreclosures can create a serious blemish on a property’s title
When a property is foreclosed due to delinquent taxes – it creates a significant blemish on the property’s title – one that most title insurance companies will not immediately insure. As a result, it can be difficult to flip a property that you purchased out of tax foreclosure, because if you can’t get title insurance, the new buyer can’t get a mortgage, which means most potential buyers simply can’t buy your property!

It is possible to solve this problem in a couple of different ways:

1. You can pursue a quiet title action, which can take three to six months but it will clear any title issues through the courts. Typically, the cost ranges from $500 to about $2,500 (all in).2. You can use a tax deed title clearing service. Assuming the county followed the correct procedures (and the vast majority of them do), this option typically takes about three months but is not available in every county.

At most tax sales – payment is required almost immediately after purchase

Immediate Payment. This is not such a problem but it goes back to having complete knowledge of the process for the particular county. If you fail to pay the full amount at the time of purchase, your purchase will be cancelled and this could result in you losing your deposit and/or being disqualified from future sales.All Cash – No Financing. It is easy to understand why a county requires cash after you “win” the bid on any given property.  They need to collect and do not want to have to deal with chasing down investors. Most investors do not have a huge pile of cash to start with especially when they are just starting out.  If you are after a particular property that gets bid above the price you’re able to pay, which will happen, especially if you are trying to purchase in the 30% to 50% of current market range, you simply miss out.  Given the fact that auctions have a way of creating a frenzy on some properties you can expect to see some sent WAY out of “the good deal” range. Many simply set their max investment too low, unreasonably too low.

Many claim that they have a difficult time finding deals on properties they actually want to buy

The best advice for a new investor getting involved in tax auctions is to treat it as a numbers game.  If an investor were to attend only one auction, then the probability of being the winning bidder would be greatly reduced compared to an investor who attended ten auctions. The primary barrier is preparing for the auction, gathering the knowledge and data needed to perform the proper due diligence. The data is a completely separate subject that we will go into later.

For the same reason you will always have trouble finding great deals on the multiple listing service (MLS), I’ve always had trouble finding great deals on properties at an auction too.When you break down the process, the main premise of an auction is to create an environment in which bidders have to compete with each other to buy things. Auctions are designed to work toward the benefit of the seller (i.e. – the county) and in most cases, it does.

This does not necessarily mean that deals can’t be found at a tax sale because they can, properties often sell below 50% of current market value.  Investors find them routinely, but the fact is, an investor’s ability to succeed in this kind of buying environment is highly contingent on his or her ability to gather the needed due diligence data and also depends on who else is in the room and what they’re willing to pay for the same properties.

This auction process can be a little annoying and disappointing. The property you may have your eye on could easily have another contender who is willing to bid the price far above your set mark that would make it a profitable investment for you or anyone else for that matter. There are people at the auctions that are buying a home they plan to live in and they would easily bid to 80% of current market value.

Every investor has to choose which strategies they’re going to pursue and which strategies they’re going to ignore, and this should be one you pursue. It takes hard work to invest in real estate but when you have the ability to purchase real estate at a significant discount or invest in a lien that pays a high rate of return and both are secured by a tangible asset, it is worth all of the hard work.

Why is the System Flawed (How Can Formalytx Help Me?)

From the items listed above, there are a series of issues that make the tax auction purchasing system unappealing, time consuming, and in many cases not worth the effort. That’s where Formalytx comes in.Remember how we said auctions take place throughout the year? To find that information now, you must go to each county website, search for the date for that year, write it down, find out when their properties will become available for viewing, etc.

With Formalytx not only can you view an entire yearly calendar of county auction dates, but you can also go as far as to search for specific types of properties you desire within the property release list.

For more information on how Formalytx can help you through this process, please visit our “How it Works” page