Low-Risk Profits from Tax Liens and Tax Deeds

Most real estate taxes are local ad valorem taxes, assessed by municipalities. If real estate taxes are unpaid, then the tax authority will either place a lien on the property or foreclose on the property, depending on the state. Tax liens have the highest priority over all other liens, including mortgage liens. Tax rates are assessed on the property value, with higher property values incurring higher taxes.

Penalties and interest are also assessed on unpaid taxes. A property with a tax lien cannot be sold, transferred, mortgaged, or refinanced until the lien is paid. Anyone doing a title search will discover the lien and either will not buy the property until the lien is paid or they will pay it themselves. In either case, the lien gets paid.

Rather than waiting for payment to remove a tax lien or to hold foreclosed property that is not generating any tax revenue, most municipalities sell their tax liens or tax deeds to investors, who then receive any subsequent payments to either remove the lien or to redeem the property. Buyers of tax liens will generally receive a tax certificate as evidence of their lien, and buyers of tax deeds will have the property. The municipalities of about half of the states sell tax liens; the rest, tax deeds; a few states allow municipalities to sell both.

However, most states have a statutory redemption period that allows the owner to pay the back taxes or loan payments before the property can be transferred with a clear title. The tax certificate holder can expect payment within the redemption period or after the end of the redemption period, since by then, the property will be foreclosed and sold to another buyer, which could be the lienholder. In most tax deed states, the tax deed will not be sold until after the redemption period, but in a few states, such as California or Texas, the tax deed may be sold before the redemption period, in which case, the tax deed holder will not have clear title until the redemption period ends. If the property is redeemed, then the tax deed holder will receive the payments including penalties + accrued interest.

Although there are few risks in buying tax liens or even tax deeds, the main disadvantage with tax liens is that the investor does not know exactly when payment will be received, so the money will be tied up until then. In the case of tax deeds, the investor will own the property, thus inheriting all the risks of property ownership. Additionally, the title may have to be cleared.

Tax lien sales are sold in auctions, usually advertised in local newspapers. The auctions are open to the public and investors do not have to be state or local residents to participate. Occasionally, tax liens and deeds are sold over-the-counter, mostly unsold liens or deeds from the auction.

The successful investor of tax liens or deeds will need to know when and where the auctions are conducted and the procedures that must be followed. Although much of the information is available online, a potential investor may need to contact the county treasurer to find out specific information on auctions and procedures for buying tax certificates or deeds. Any potential investor would also need to conduct thorough research on the local properties and market, and the investor would also need to know the state and local laws regarding tax liens or deeds and the procedure for clearing the title on foreclosed properties.

Tax Liens

Buying a tax lien requires paying the taxes on the property, so the profit is earned from penalties plus the interest that accrues until the property owner pays the taxes.

When an investor buys a lien, the county tax assessor or treasurer will continue to collect any tax payments plus interest and penalties, but the treasurer will remit the collected payments to the holder of the tax lien certificate. The interest rate, ranging from about 6% up to 24% or even higher is set by local and state statutes. Generally, states with longer redemption periods pay higher rates.

Profiting from tax liens is easier and requires less capital than for tax deeds. Tax liens have the highest priority, even over senior mortgage liens. If the tax lien is not paid, then the holder can foreclose on the property.

Since penalties are for specific amounts, the early redemption of a tax lien is advantageous for the investor because it means a higher rate of return will be earned over a shorter duration. However, the interest earned from tax liens will vary. Many auctions for tax liens are reverse-bid auctions, where the winning bidder is the one willing to accept the lowest interest rate on the lien. Although statutory interest rates do not change often, the bid interest rate, like the interest on bonds, will vary with prevailing market rates. If market rates are high, then most investors of tax liens will not accept a lower interest rate than what can be received from interest-paying financial instruments, such as bonds. However, when interest rates are low, the bid interest rate on tax liens will generally be higher than on bonds. During times of low interest rates, the interest rate can be quite low, 7% or less. If the property owner does not pay the lien within a specified time, such as 4 years, then the investor can petition the court to force a tax sale auction. The highest bidder may not be the lienholder. However, the lienholder may lose if the tax sale is not sufficient to cover the lien plus interest.

Tax Deeds

Tax deeds originate when the tax authority forecloses on the property and actually owns the property. Therefore, buyers of tax deeds will actually be buying the property, usually for considerably less than the assessed value.

Like tax liens, tax deeds are sold in auctions, and sometimes over-the-counter. Investors can find the procedures for bidding on tax deeds either online, usually at the county's website, or by contacting the county treasurer's office.

Tax deeds are generally quitclaim deeds, sometimes called a sheriff's deed, so a major risk with tax deeds is the unknown cost to clearing the title. Most title insurance companies will not cover tax deeds.

Buying a tax deed is riskier than buying a tax lien, for the buyer is essentially buying the property and will have all liabilities of that property. Hence, insurance must be purchased and taxes must be paid on the property. For this reason, tax deeds require more due diligence, just as if the investor were buying a home. Potential investors should determine why the previous owners did not pay taxes on the property. The property may have little residential or commercial value, or there may be undesirable easements or the property may be landlocked, meaning that it cannot be accessed over public roads.

Sometimes the property is sold even during the redemption period, but the original owner still owns the property and, except for Texas, has all the rights and benefits of that ownership during the redemption period. The owner can still occupy it, lease it, or even sell it, but if the property is sold, then the holder of the tax deed must be paid past due taxes including interest and penalties. (Some states allow sales within the redemption period because properties are rarely redeemed.)

Texas and California, for instance, allow the right of redemption even after the sale of the tax deed. In some states, like Texas, the tax deed holder will be entitled to any leases or other types of revenue earned during the redemption period, even if the property is redeemed.

To bid on properties, at least the following information is required:

Types of Auctions

Auction size can vary from a few people to hundreds. While larger auctions are more competitive, they also have more liens or properties to sell. Some representatives from big institutional investors may also be there, but they will be mostly interested in the larger properties, leaving many of the smaller parcels for smaller investors.

Some auctions are conducted online, in which case the investors must preregister for the auction and make a deposit at least a certain number of days before the auction. A performance bond may also be required to bid.

The winning bidder must pay for the property by the end of the auction, either in cash or by cashier's check. Personal or business checks are not accepted because payment is not guaranteed.

Different types of bidding are used throughout the country including: premium, bid-down interest method, lottery or rotational bidding, first-come, first-served, and even random selection.

Premium bidding is the most common type of bidding, with the lien or property going to the highest bidder. Generally, there is a minimum bid, and the auction proceeds from there. However, in some jurisdictions, the interest rate is only paid on the minimum bid and not on any premium paid by the investor. So if the minimum bid was $4000, but the investor paid $6000, then interest only accrues on the $4000. If the property owner redeems the lien, then the lienholder will receive what was paid for the lien, but may only earn interest on the minimum bid.

Generally, interest is less of a concern for the tax deed auction, because the winning bidder receives the property. However, in those states that allow redemption even after the sale, then the interest rate should be considered, since that will be the return earned by the tax deed holder.

As with most auctions, if the county uses an outside auction company instead of conducting the auction itself, then there will generally be a bidder's premium of about 10% added to the bid.

The bidding-down interest method applies to liens, where the winning bid accepts the lowest interest rate. The tax authorities still collect the full interest rate allowed by law, but pay only the cost of the lien plus the bid interest to the lienholder; the rest is kept by the tax authority.

First-come, first-served auctions accept the 1st bid for the full lien amount.

Over-the-counter sales are offered in some states, where investors can bid on property that was not bought in auctions. The minimum bid may either be lowered or eliminated so that the county can sell the property.

Winning bidders of tax lien sales usually receive certificates for the tax liens, which may have to be returned if the property is redeemed. Winners of tax deeds will receive the deed, that may have already have been recorded. But if the deed was not recorded at the county's recorder office, then the investor must record the deed. Additionally, tax deed holders may have to pay current taxes and all taxes for subsequent years for as long as they own the property.

If the property is not sold at auction or over-the-counter, then it may be forfeited to the state.


Repopulating Detroit with Tax Deed Sales

Detroit is rebuilding after filing, in 2013, the largest municipal bankruptcy in history. Even before the bankruptcy, the population of Detroit has been declining for years, leaving many empty, abandoned houses, greatly reducing the tax base. Most of these properties are tax lien foreclosures that are being sold to people willing to live in the homes. Potential bidders can register online and find additional information at www.buildingdetroit.org.

Detroit wants to improve the community, so any winning bidders must actually live in the house for a specified time. The winning bidder will also have to pay real estate taxes and other costs from July 1, 2014 until close, and, of course, will also be liable for all expenses incurred after taking title. The auctions last 1 day and bids must be in $100 increments. The winning bidder must obtain a certificate of occupancy and live in the house within 6 months of closing, 9 months if it is in a historic district. Bidders must submit a $1000 authorization on a credit card that will only be charged if the bidder wins. Thereafter, 10% of the price must be deposited within 72 hours and the transaction must be closed within 60 days.

Because a certificate of occupancy must be received within a short time after closing, winning bidders must fix the house for habitation within that time. Many of these homes require water heaters, furnaces, and other major appliances. Additionally, because the assessed value on the homes will not be changed by the tax deed sale, former assessments will still apply, which may lead to a property tax bill as high as $10,000 per year.

Here is a typical house that was being sold on 6/2/2015: a 1917 brick American 4 Square-style 1800 ft.2 home with 2 baths, 4 bedrooms, bay window, attached 2-car garage, large front porch, rear deck, wood floors, and brick fireplace. Minimum bid: $1000. There was a total of 41 bids for this property, which sold for $7,600 on June 29, 2015.

The Pre-Sale Housing Inspection Report for this property, prepared by the Buildings and Safety Engineering Department of Detroit, had a long list of defects that needed to be repaired. After the repairs, a re-inspection must be conducted within 6 months before a Certificate of Approval can be issued. The inspection report only covered the items that were on the pre-printed list. The inspector was not required to look for latent defects or activate the heating or air conditioning system to check their functional status. The inspection also does not cover formaldehyde, radon, asbestos, lead-based paint, or insect damage, such as by termites.

One condition of the sale is that the house be made habitable within 6 months, or 9 months for historic structures. Failure to rehabilitate the property within the required time, including extensions, will cause the property to be reconveyed to Detroit, with the sale proceeds serving as liquidated damages.

Tax deed sale for a 1917 brick American 4 Square-style 1800 ft.2 home with 2 baths, 4 bedrooms, bay window, attached 2-car garage, large front porch, rear deck, wood floors, and brick fireplace.

Foreclosing and Obtaining Clear Title

Usually, the lienholder will eventually get paid, but, if not, then the lienholder must foreclose on the property. As long as the investor holds only the lien, then there is no liability for the property, but the lienholder will receive any notifications concerning the property, such as a recording of a new lien or property violations.

To take legal title to a property, it must be foreclosed. However, there will probably be clouds on the title. Moreover, the deeds to properties sold in tax deed sales are quitclaim deeds that convey only the previous owner's interest in the property, but does not necessarily guarantee clear title. Therefore, deeds obtained through foreclosure and tax deeds should usually be perfected by filing a quiet title action in the appropriate court, since a property with a clear title is more valuable. The lawsuit and the summons are served on the property owner and anyone with a recorded interest in the property, such as a mortgage company. If the previous owner died, then a notice must be published in the local paper, so that any creditors can file a claim on the estate, which will include the property. When the court determines that all required notices were published, and the redemption period has expired, then the court will adjudicate that the title is clear and free.

With a recent declaration of quiet title for the property, the property owner can ask for a reissue rate for title insurance, which is cheaper than the regular rate.