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Tax liens and deeds are a popular investment for taxpayers who wish to reduce their taxes and increase the return on their investments. This is not an easy task, but with high-interest rates, it can be done without much effort.
Tax lien investments are a type of real estate investment that has many benefits. This article will give you all the information you need to know about tax lien and tax deed investing.
Investing in tax liens and tax deeds entails purchasing property whose owners have fallen behind on their property taxes. Tax liens provide income for investors in the form of interest and, in certain cases, penalties. If the property owner fails to settle their debt, investors might possibly buy below-market property via tax liens and tax deeds.
What Are Tax Liens and Tax Deeds and How Do They Work?
The county or local government where the property is situated has the ability to either put a lien on the property or foreclose and sell it for back taxes if the owner is late on their property taxes.
If a tax lien is placed on a property by the municipality because the owner does not pay their overdue taxes, the lien is sold to an investor, who is then entitled to interest from the owner until the default is addressed.
Owners may have as little as 3 months or as much as 2 years to settle the debt (depending on the state), during which time the investor holding the tax lien certificate may incur interest and penalties. The investor gets refunded their investment plus accumulated interest and fees on the day the debt is settled.
If the town opts for the tax deed method, the property is auctioned off to investors, who may get the title in as little as one day. Most places, on the other hand, provide the defaulting owner a redemption time, generally no more than a few months, during which interest and potentially penalties will accumulate and be paid to the investor. If the owner fails not to redeem, the investor will foreclose on the property.
Purchasing a Tax Lien vs. Purchasing a Tax Deed
Investing in tax liens and tax deeds are two separate things. Tax lien investing is obtaining tax lien certificates mainly for the purpose of earning interest and, if applicable, penalty revenue. When it comes to tax deeds, the focus is on getting a below-market property via the tax foreclosure procedure. Tax liens and deeds are available in different states.
Basics of Tax Lien Investing
Tax lien investment offers the possibility of earning higher-than-market interest rates while posing no risk. Tax lien certificates have interest rates as high as 16 percent, and penalties may increase the effective return even further.
When a property fails to pay its taxes during the grace period, the municipality adds interest and penalties to the amount outstanding. The municipality will eventually issue a tax lien on the property, and it will be sold during the yearly tax lien sale. The tax lien will be sold to an investor at the auction and will be known as a tax lien certificate.
When you purchase a tax lien certificate, you are essentially paying the amount owed by the owner (taxes, interest, and accrued penalties). The bearer of the certificate is entitled to all future interest and penalties until the owner redeems the certificate. To redeem, the owner must pay the entire amount you paid for the certificate, plus any interest and penalties that have accumulated.
Let’s imagine a property owner owes $1,000 in property taxes and lives in a state where 14 percent interest plus a $35 penalty is charged every six months. When the property owner pays off the loan, you buy the property and keep it for ten months. The following is a breakdown of earnings:
Investing in Tax Liens as an Example
In this situation, you’ll get $1,187 when the tax bill is entirely repaid, which would take 10 months in this case.
Tax lien certificates are available on any kind of property in the states that employ this system, including residential, commercial, multifamily, and unoccupied land. Tax liens on an abandoned property may occasionally be found for less than $100. Tax liens on small developed properties might cost as little as a few hundred dollars.
Furthermore, as a tax lien investor, you must consider the chance that the owner would fail to redeem — that is, pay their obligation – and you will have to foreclose on the property. You may foreclose on the property if all legal redemption periods have elapsed, and you will have successfully acquired it for the sum of your offer.
Basics of Tax Deed Investing
Investing in tax deeds differs from investing in tax liens in that you are bidding directly on the property rather than on a lien. If you are the winning bidder, you have the option of foreclosing on the property if the owner does not redeem the property by paying their tax bill. You might earn interest and penalties throughout the redemption period.
Other states, on the other hand, are less lenient and will sell the property on the day of the tax deed auction. As a result, if you place a winning offer, you will be able to purchase the property the same day for the sum of your winning bid. It’s more likely, though, that you’ll have to wait out the legal term during which the property’s owners have the right to pay their debts and reclaim the property.
Here’s an example of a tax deed transaction that went well:
Tax Lien & Tax Deed Investing on Property With Existing Liens
What if the property you’re bidding on already has a mortgage or other encumbrance on it? Tax liens are considered senior liens in tax foreclosures, whether in lien or deed states. Mortgages and other liens will be wiped away when the property is sold, leaving investors with a title that is free and clear of encumbrances.
The reasoning for this is that if lenders or other lien holders want to preserve their interest in the property, they must pay the late property tax payment. If they don’t, the law assumes they’re giving up their right to sue.
Where to Find Tax Liens & Tax Deed Auctions and Sales
The process of selling a home differs from state to state. Many small counties still have Auctions in Real Time, which might be conducted in the county courthouse or elsewhere in the community. However, due to their efficiency, an increasing number of municipalities are switching to online auction methods.
Auctions in Real Time
Throughout the country, many municipalities and counties still use a traditional live, onsite auction process to sell both tax liens and tax deeds. Generally, these are smaller communities, often more rural ones which either don’t have the capabilities to use an online auction platform or don’t have enough tax defaults to warrant that approach. Contact municipal or county treasurer’s offices for information on Auctions in Real Time.
Auctions on the Internet
Whether selling tax lien certificates or tax deeds, officials in most bigger markets have resorted to different online auction organizations to manage their tax-defaulted assets. The following are some of the most popular platforms:
Because many of these firms have privately branded their internet platforms with the counties they serve, you are unlikely to be aware of their participation. As a result, they seem to be part of the county’s processes.
Types of Tax Lien & Tax Deed Auctions and Sales
Counties conduct two forms of tax delinquent property sales: tax lien certificates and tax deeds. Some people prefer an auction, while others prefer a direct sale. Tax delinquent property might be sold in one of four ways: Tax lien auctions, tax deed auctions, and tax deed sales are the three types of tax deed auctions. Florida is the fourth state to employ a hybrid strategy.
1. Auctions of Tax Liens
Tax lien auctions may be conducted live, on-site, or online using a variety of platforms. Bidding may take a variety of forms, which are described here. Regardless of the approach used, the aim is to get the tax lien certificate in order to receive interest and, depending on the state, penalty money.
2. Auctions of Tax Deeds
Tax deed auctions may be done live on-site or through a variety of online auction platforms. The amount of past taxes, cumulative interest, and any penalties previously imposed are usually the starting points for bidding. Tax deed auctions usually follow a fairly standard real estate auction pattern, with buyers competing on price and the property going to the highest bidder.
Winning a tax deed auction does not guarantee that you will get the property. Property owners in most jurisdictions have a “period of redemption” during which they may make good on their debts. If that occurs, you’ll lose the property, but you’ll get a return on your investment in the shape of interest and penalties.
3. Sales of Tax Deeds
Some states don’t have deed auctions at all, instead of selling tax delinquent properties directly to purchasers. The majority of these are available via the treasurer’s office at the local municipal or county level. Some governments use legal firms to conduct the sales. To find them, you’ll need to do some local investigation.
Unlike auctions, the prices established tend to be very near to market value, so although you may be able to purchase a house for less than market value, it won’t be a penny-on-the-dollar bargain.
4. Sales of Hybrids
Some states, particularly Florida, use a hybrid approach that combines tax lien and tax deed sales. Investors are permitted to buy the tax lien and retain it until the property owner pays off his or her obligation or the property falls into tax foreclosure. Investors get interest and penalties up to that moment, just as they would in a tax lien scenario.
Hybrid states, unlike other lien jurisdictions, do not enable the tax lien holder to foreclose if the property is in full tax foreclosure. The delinquent property is subsequently sold at a tax deed auction, where buyers fight to buy it.
How to Buy Tax Liens & Tax Deeds
To acquire a tax lien certificate or a tax deed successfully, you must first master a fairly basic technique. Learning how to investigate qualities of interest is the first step. Then you’ll discover how to take part in different types of auctions. Finally, there’s the profiting phase, which might include receiving interest or purchasing a discount home via tax foreclosure.
Step 1: Before the auction, do some research on the tax sale property.
While it’s common for buyers to bid on tax sale property without seeing it first, it doesn’t mean you shouldn’t do your homework. You’ll want to know what you’re bidding on and come prepared with a list of homes that suit your requirements. To perform your research, you may use one of four entities, the majority of which can be done online:
- County Treasurer — This agency is in charge of the sale and will have a list of properties scheduled for the tax sale auction many weeks ahead of time. Begin by making a list.
- County Assessor — Use the county assessor’s office to search up the possible worth of a piece of interest.
- Recorder of Deeds – You may check with the recorder’s office to see whether there are any additional liens, claims, or judgments against the property, such as an existing tax lien or even an IRS lien. Tax delinquent property owners are prone to such problems. You may want to avoid bidding on a property that has a lot of claims against it.
- Whether you’ve discovered any properties that you like, you may check their plat maps and aerial views to determine if they’re worth considering. Many tax sale plots are landlocked, oddly shaped, miles from any development, or have no road access, rendering them practically useless.
Step 2: Pay any auction fees or deposits that are due.
During the auction process, many auctions charge fees or deposits.
- Non-refundable charges are referred to as fees. Some countries charge all bidders a participation fee merely to participate. Others only charge fees if there are real bids. In any case, the fees must be included in your final profit. To participate in yearly certificate sales, several Arizona jurisdictions levy non-refundable fees of $125-$150.
- Refundable charges are referred to as deposits. This is a strategy for counties to guarantee they have serious bids by requiring bidders to have some “skin in the game.” Those who did not bid or win their deposits are returned at the conclusion of the auction. Deposits are usually deducted from the winning offer, leaving the buyer with just the balance owed. In California, most counties need deposits ranging from $2,500 to $5,000.
Step 3: Place a bid at a tax lien or deed sale.
You’re ready to go to the auction after you’ve made a list of possible properties. As previously said, you may be attending a live auction in the county courthouse or another venue. You might also bid online using the county’s approved mechanism.
Understanding Tax Lien and Tax Deed Auction Bidding Formats
Bidding on tax deeds – and particularly tax liens – is not as straightforward as it is at a traditional auction. Many governments, counties, and municipalities have implemented numerous inventive ways that bidders must employ throughout the years. The following are the five primary methods:
1. Increase the Price Bid
This is the classic auction style, in which bidders compete by increasing their bids against one another. The starting bid at a tax auction is normally set at the sum of unpaid taxes plus any accrued interest and penalties. Bidders will boost their offering price from there in this kind of auction.
The number shows the amount the bidder is prepared to pay if the property is repossessed in a deed scenario. It usually signifies the amount the bidder is prepared to put on the certificate in a lien scenario. Because interest is still calculated on the amount of past taxes and interest/fees owing, the higher the investor’s offer, the lower the return.
2. Reduce interest rates by bidding them down
Arizona and a few other states employ one of the most common bidding systems. It’s dubbed “bid down interest” because that’s exactly what competitive bidders do: they reduce the amount of interest they’ll take. In Arizona, for example, the specified interest rate is 16 percent. Bids will fight with one another to work that backward, and it’s not unusual for bidders to accept interest rates as low as 4%.
3. Participate in Premium Auctions
Some jurisdictions that employ conventional auction bidding systems have implemented a bid premium to address a flaw in the system that enabled individuals to bid more and more with no actual limit. In other words, it’s to help prevent $200,000 bids on $100,000 assets that make no sense since bidders knew they didn’t have to pay because of auction processes.
A bid premium is often a percentage of the amount bid over the property’s fair market value. In Maryland, for example, where there is a bid premium, someone who bids $200,000 on a property worth $100,000 would have to pay the county $32,000 in addition to the taxes, interest, and penalties. The premium is maintained in perpetuity until the owner redeems the property or the property falls into foreclosure. In any case, it takes a long time to save $32,000 without paying interest, so that helps keep offers in control.
4. Lottery
Very few locations offer this, and it’s usually with Auctions in Real Time. In an auction lottery, a parcel is offered for sale, but only to the person whose lottery number is drawn. If the person bids, generally, they win the process. If they decline, another lottery number is drawn, and that person is given the option of bidding a figure.
5. After the auction, purchase tax liens or tax deeds
In many areas, the tax sale isn’t the only way to purchase a tax-foreclosed property. Many tax-defaulted properties are never auctioned, and many counties and municipalities have their own procedures of selling those properties that wind up on their books. There are two options for following the auction:
- Over-the-Counter Tax Lien Certificate Sales — If a county in a lien state has unsold tax liens, they often make them available via “over the counter” sales. A purchaser may get a county-held certificate for the amount of delinquent taxes, accrued interest, and penalties at any time following the auction. It’s first-come, first-served, with no bidding.
- Property that is not sold at auction in deed states becomes the property of the city or county and is often put up for sale. When unsold liens expire in lien states, the properties return to the county or city.
On the treasurer’s website, you may access a list of county-held tax lien certificates – or property.
Step 4 – After the Tax Sale, Wait During Any Redemption Period
Because most jurisdictions, both tax lien and tax deed states, have processes in place to enable property owners to repay their debts and regain their property, the next step is to just wait. The redemption term might be as short as a few months in certain circumstances, while it can be as lengthy as a couple of years in others.
An owner may redeem the lien at any moment during that time period, and you’ll be paid your bid plus any accumulated interest and perhaps penalties for the time you held the lien.
Keep in mind that if the owner fails to redeem, you may file a foreclosure action to take possession of the property.
Step 5 – Profit With Your Tax Liens & Tax Deeds
Collecting interest, earning penalty revenue, and perhaps obtaining property for the amount of past taxes are the three main ways to profit from tax lien certificates and tax deeds.
Here’s how tax liens and tax deeds may make you money:
- Interest – the aim of tax lien certificates is to earn a good interest rate on the money you spend. Depending on the state, interest rates might be as high as 12 percent to 16 percent. Because the liens are guaranteed by the municipality, and there is no market volatility, your return is extremely low risk.
- Fines — Many states impose penalties on tax-delinquent property owners in addition to interest. These fines are passed on to the certificate buyer. In rare cases, penalty income might boost your profits by as much as 40%, depending on the scenario.
- Purchasing Property at a Discount to Market Value – The purpose of tax deed investing is to purchase property at a discount to market value. Although only approximately 1% of tax liens result in foreclosure, it is nevertheless conceivable. Foreclosure is a straightforward procedure in certain jurisdictions, using a tax deed or sheriff’s deed. In certain places, it’s a complicated procedure that needs the assistance of a lawyer.
Investing in Tax Liens or Tax Deeds Comes With Risks
Tax liens and tax deeds are largely risk-free investments, which is one of their selling points; nevertheless, they do have certain drawbacks that you should be aware of.
Tax debt that has accumulated
Tax debt may develop on a property under certain circumstances, and you may get engulfed in it. This is prevalent among property owners who regularly allow their property to go into tax default, never fix the situation, and continue to accrue tax debt.
Here’s an example. A not-so-great building lot worth $4,000 has gone into tax foreclosure for 6 years, accumulating $600 in back taxes each year. So, there is $3,600 in Tax debt that has accumulated on a parcel valued at $4,000. Why bother? If you didn’t do your research and mistakenly bid another $600 (or more) on that lot, you can’t profit from the situation. What’s likely is that your $600 will be tied up in the lien indefinitely.
A piece of junk property
If you don’t do your homework on the property you’re bidding on, you can wind up with something worthless that you don’t want. This means you won’t be able to get your money back.
Consider the following scenario: you purchase a tax lien on what was formerly a junkyard. You will never earn any interest since the owners will never redeem. When the time comes to foreclose, you know what you’re up against and that there’s no way you’ll ever be able to resell that lot, even if you buy it for the amount of unpaid taxes your winning offer represents. It’s possible that you’ll never sell the property since it’s unappealing. In fact, it’s possible that’s how it got into tax default in the first place!
Bankruptcies
Bankruptcies are the one legal loophole that can cause all kinds of trouble for tax-sale real estate investors. In short, a bankruptcy can halt any kind of collection efforts, whether it’s for interest & penalties or for foreclosing on a complete default. The good news is, that tax liens and tax deeds are priority claims, so as the bankruptcy is resolved, you are among the first in line to get paid. Of course, as a bankrupt, you never know how much that amount will be.
Conclusion
Depending on the area, tax liens or tax deeds are used to invest in tax delinquent property. Tax lien investment is primarily for the purpose of generating above-market interest, while tax deed investing is mostly for the purpose of acquiring a low-cost property. Owners may retrieve their property at certain redemption times, while investors receive interest. Investors typically have the right to foreclose after that.
