Everything You Need to Know About Tax Lien and Tax Deed Investing

Tax lien investing and tax deed investing involves buying property on which owners have become delinquent paying their property taxes. Investors profit from tax liens by earning interest and sometimes penalties. Investors can also potentially acquire below-market property both with tax liens and tax deeds if the property owner ultimately fails to repay their debt.

How Tax Liens and Tax Deeds Work

When an owner is delinquent on their property taxes, the county or city government where the property is located has the authority to either place a lien on the property or foreclose and sell it for back taxes.

If the municipality places a tax lien on the property because the owner fails to make good on their delinquent taxes, the lien is sold to an investor, who is then entitled to collect interest from the owner once the delinquency is resolved.

Owners may have as few as 3 months or as long as 2 years to resolve the debt (depending on the state) during which time interest and penalties accrue to the investor holding the tax lien certificate. If/when the debt is resolved, the investor is reimbursed their investment plus accrued interest and fees on that date.

If the municipality uses the tax deed approach, the property itself is auctioned off to investors who may end up with the title in as little as a day. However, most locations give the defaulting owner a period of redemption, usually no more than a few months, during which interest and possibly penalties will accrue payable to the investor. After which, if the owner doesn’t redeem, the property is foreclosed by the investor.

Investing in a Tax Lien vs Tax Deed

Tax lien and tax deed investing are different processes. Tax lien investing involves purchasing tax lien certificates, primarily to earn interest and if available in the locale, penalty income. With tax deeds, the investing emphasis is on possibly securing a below-market property through the tax foreclosure process. Individual states can offer tax liens or deeds.

Tax Lien Investing Basics

Tax lien investing provides the potential for above-market interest rates with very little risk. Interest rates on tax lien certificates can run as high as 16% and penalties can make the effective return even higher.

Once a property bypasses any stipulated grace period for paying their taxes late, the municipality levies interest and penalties on what is owed. Eventually, the municipality will place a tax lien on the property, and the property will be slated for the annual tax lien sale. At the sale, the tax lien will be sold to an investor, at that point called a tax lien certificate.

When you buy a tax lien certificate, you are basically paying the amount of owner’s indebtedness (taxes, interest, and accrued penalties). The holder of the certificate is entitled to any the interest and penalties going forward until the owner redeems. In order to redeem, the owner must fully pay off the amount you originally paid for the certificate plus all the accrued interest and penalties.

So, let’s say a property owner is delinquent on their property tax bill of $1,000 and are in a state that charges 14% interest plus a $35 penalty every 6 months. You acquire the property and hold it for 10 months when the property owner finally pays the indebtedness. Here’s a breakdown of earnings:

Tax Lien Investing Example

In this example, you’ll earn the $1,187 after the tax debt is fully redeemed, in this case after 10 months.

In the states that use this system, tax lien certificates are available on any kind of property – residential, commercial, multifamily, and vacant land. You can find tax liens on vacant land sometimes for less than $100. Tax lien certificates on modest developed properties can start at only a few hundred dollars.

In addition, as a tax lien investor, the possibility exists that the owner may fail to redeem – may fail to pay their indebtedness – and you can foreclose on the property. If after all legal periods of redemption have expired, you can foreclose on the property – and will have effectively purchased it for the amount of your bid.

Tax Deed Investing Basics

Tax deed investing is different from tax lien investing in that you are bidding directly on the property rather than on a lien. If you’re the winning bidder, you have a chance to foreclose on the property if the owner doesn’t redeem by paying their tax debt. During the redemption period, you can earn interest and penalties.

Other states are not as forgiving and will sell off title the day of the tax deed auction. So, if you are a winning bidder, you’ll acquire the property that day for the amount of your winning bid. However, it’s more common that you will have to wait through the legal period of time in which owners have the right to pay their indebtedness and redeem the property.

Here’s an example of a successful tax deed purchase:

Tax Deed Investing Example

Tax Lien & Tax Deed Investing on Property With Existing Liens

What if the property you are bidding on has a mortgage or other existing lien? In tax foreclosures, whether in lien states or deed states, tax liens are considered senior liens. In effect, mortgages and other liens will be wiped out upon sale and investors will acquire title free and clear of encumbrances.

The rationale behind this is that the law expects lenders or other lien holders to step in a pay the delinquent property tax bill if they wish to protect their interest in the property. If they fail to do that, then the law presumes they are waiving their claim.

Where to Find Tax Liens & Tax Deed Auctions and Sales

The method for selling properties varies across the country. Many small counties still use live auctions which may be held at the county courthouse or in a local venue. However, more and more municipalities are moving to online auction formats because of their efficiency.

Live Auctions

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 live auctions.

Online Auctions

Officials in most larger markets have turned to various online auction companies to handle their tax-defaulted properties, whether they are selling tax lien certificates or tax deeds. Some of the major platforms are:

• Grant Street Group
• RealAuction
• ZeusAuction
• Bid4Assets

You probably won’t even be aware of these companies’ involvement because many have privately branded their website platforms with the counties they serve. So, they tend to look like part of the county procedures.

Types of Tax Lien & Tax Deed Auctions and Sales

Counties hold two types of sales for tax delinquent property, whether it’s for tax lien certificates or tax deeds. Some use an auction process and others use a direct sale. There are four ways tax delinquent property is sold: 1) tax lien auctions; 2) tax deed auctions; and 3) tax deed sales. The 4th is Florida which uses a hybrid approach.

1. Tax Lien Auctions

Tax lien auctions may be held live, onsite, or through various online auction platforms. There are various forms of bidding which are profiled below. No matter which strategy is involved, the goal is to acquire the tax lien certificate to earn interest income, and depending on the state, income from penalties.

2. Tax Deed Auctions

Tax deed auctions also may be held live and on-site or through various online auction platforms. Bidding normally starts with the amount of back taxes, accumulated interest, and any penalties already levied. Tax deed auctions tend to follow a fairly traditional real estate auction format, with bidders competing with each other on price, with the high bidder winning the property.

Winning a tax deed sale does not mean you necessarily win the property. Most states have what’s called a “period of redemption” in which property owners can make good on what they owe. You’ll lose the property if that happens but will gain a return on your investment in the form of interest and penalties.

3. Tax Deed Sales

Some states bypass the deed auction process entirely and simply offer tax defaulted properties for sale directly to buyers. Most of these are offered at the local municipal or county level, usually through the treasurer’s office. Some jurisdictions engage law offices to handle the sales. It takes researching at the local level to uncover these.

Unlike the situation with auctions, the prices set tend to be fairly close to market value, so while you can get a below-market property, it won’t likely be a pennies-on-the-dollar deal.

4. Hybrid Sales

Some states – Florida in particular – have a hybrid process involving a combination of tax lien and tax deed sales. What happens is that investors are allowed to purchase the tax lien and hold it until either the property owner makes good on his/her debt or it goes into tax foreclosure. Up until that point, investors earn interest and penalties just like in any tax lien situation.

However, unlike most lien states, hybrid states don’t allow the tax lien holder to foreclose if the property goes into complete tax foreclosure. The defaulted property then goes to a tax deed sale in which bidders can compete to purchase the property.

How to Buy Tax Liens & Tax Deeds

Successfully buying a tax lien certificate or tax deed requires learning a very simple process. The process starts with learning how to research properties of interest. Then, you learn how to participate in the various forms of auction. Finally, there’s the process of profiting, whether it’s being paid interest or acquiring a bargain property through tax foreclosure.

Step 1 – Research Tax Sale Property Before the Auction

While bidders regularly bid on tax sale property sight-unseen, that doesn’t mean you sidestep any kind of research. You want to know what you are bidding on and go into the auction with a list of properties that meet your bidding criteria. There are 4 entities to utilize to conduct your research – much of it can be conducted online:

• County Treasurer – This is the office that conducts the sale and will have a list of properties slated for the tax sale auction several weeks before the auction. Begin with that list.
• County Assessor – When you have a parcel of interest, use the county assessor’s office to look up their potential value.
• County Recorder – At the recorder’s office you can investigate whether there are other liens, claims or judgments – like an existing tax lien, or even an IRS lien against the property. Such issues can be common with tax delinquent owners. You may not want to bid on a property with a lot of claims against it.
• County Surveyor – If you’ve found listings of interest, you can look up their plat maps and aerial views to see if they are worth considering. Many tax sale parcels are landlocked, are unusually shaped, sit miles from any development, or have no road access, making them virtually worthless.

Step 2 – Pay Any Auction Fees and Deposits

Many auctions levy fees or deposits in the auction process.

• Fees – Charges that are non-refundable. Some jurisdictions charge fees to all bidders just to participate. Others charge fees only against actual bids. Either way, the amount of the fees must be calculated into your yield. Many Arizona jurisdictions charge $125-$150 non-refundable fees to participate in annual certificate sales.
• Deposits – Charges that are refundable. This is a way that counties force bidders to have some “skin in the game” and ensure they have serious bidders. Deposits are refunded at the end of the auction to those who didn’t bid or win. For those who did win, deposits are normally subtracted from the winning bid, so the buyer only owes what remains. Most counties in California impose deposits ranging from $2,500 to $5,000.

Step 3 – Bid at the Tax Lien or Tax Deed Sale

Once you have a list of potential properties, you’re ready to head off to the auction. Noted above, you may be participating in a live sale at the county courthouse or other location. Or, you may be bidding online using the county’s designated system.

Understanding Bidding Formats for Tax Lien and Tax Deed Sales

However, bidding on tax deeds – and tax liens in particular – is not as simple as a customary auction. Over the years, many states, counties, and municipalities have adopted various creative methods bidders must use. The 5 major methods are:

1. Bid Up the Price

This is the traditional auction format in which bidders compete by raising prices against each other. With a tax sale, the opening bid is usually set at the amount of back taxes, plus accumulated interest and any penalties. In this kind of auction, bidders will increase their offering price from there.

For deed situations, the figure represents the amount the bidder is willing to pay if the property is foreclosed. For lien situations, it generally represents the amount the bidder is willing to tie up in the certificate. Interest is still generally based on the amount of back taxes and interest/fees owed, so the more the investor bids, the lower their yield is.

2. Bid Down Interest Rates

One of the more usual bidding procedures is used in Arizona and a couple of other states. It’s called “bid down interest” because that’s what competing bidders actually do – they bid down the interest they’re willing to accept. For example, in Arizona, the stipulated interest is 16%. Bidders will compete with each other to work that backward, and it’s not uncommon to see bidders accepting interest as low as 4%.

3. Bid Premium Auctions

Some states that use traditional auction bidding processes have adopted a bid premium to counteract a loophole in the process that allowed people to increasingly bid with no realistic ceiling. In other words, it’s to help stop $200,000 bids on $100,000 properties that make no sense that bidders knew, because of auction procedures, they really didn’t have to pay.

A bid premium is usually a percentage of the amount that’s bid over the fair market value of the property. Using Maryland as an example, which levies a bid premium, if someone bid $200,000 on a house worth only $100,000 they’d have to fork over to the county $32,000 along with the amount of taxes/interest/penalties. That premium is held without interest until the owner either redeem or the property goes foreclosure. Either way, it’s a long time to tie up $32,000 without interest, so it helps keep bids in check.

4. Lottery

Very few locations offer this, and it’s usually with live auctions. In an auction lottery, a parcel is offered for sale, but only to the person who’s 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. Purchase Tax Liens or Tax Deeds After the Auction

In many locations, the tax sale isn’t the only time you can buy tax foreclosed real estate. Many tax-defaulted properties never get sold at auction, and many counties and municipalities have methods of selling those properties which they end up with on their books. There are two after-auction opportunities:

• Over-the-Counter Tax Lien Certificate Sales – In a lien state, if a county ends up with unsold tax liens, they often make them available through what are called “over the counter” sales. Any time after the auction a purchaser can acquire a county-held certificate for the amount of back taxes, accumulated interest, and penalties. There’s no bidding – it’s first-come, first-served.
• County Held Property Sales – In deed states, property that is not sold at the auction becomes city or county-owned and often placed up for sale. Even in lien states, when unsold liens expire, the properties revert to the county or city.

You can find lists of county-held tax lien certificates – or property – right on the treasurer’s website.

Step 4 – Wait During Any Redemption Period After The Tax Sale

Since most states, both tax lien and tax deed ones, have set procedures to allow property owners to make good on their debt and reclaim their property, your next step is to simply wait. Sometimes, the period of time is limited to a few months; in other cases, the redemption period can last as long as a couple of years.

At any time during that interval, an owner can redeem and you’ll be cashed out and receive your bid plus any accrued interest and possibly penalties over the duration you held the lien.

Keep in mind, that if the owner doesn’t redeem you can institute a foreclosure proceeding to obtain title to the property.

Step 5 – Profit With Your Tax Liens & Tax Deeds

Profiting from tax lien certificates and tax deeds will generally fall into one or more of 3 categories: earning interest, earning penalty income, and possibly acquiring property for the amount of back taxes.

Here’s how you can profit with tax liens and tax deeds:

• Interest – with tax lien certificates, the goal is to earn a healthy interest rate on the amount of your purchase. Interest rates run as high as 12%-16% depending on the state. Your return comes with very little risk because the liens are backed by the municipality, and there is no market fluctuation.
• Penalties – many states impose penalties in addition to interest on the tax-delinquent property owner. Those penalties flow to the certificate purchaser. Penalty income can raise your returns as high as 40% in some locations, and depending on the situation.
• Acquiring Below-Market Property – the goal of tax deed investing is to acquire property below market value. While only about 1% of tax liens lead to foreclosure, it’s still possible. In some states, foreclosing is a simple process involving a tax deed or sheriff’s deed. In other states, it’s a complex process requiring a lawyer.

Risks to Investing in Tax Liens or Tax Deeds

Investing in tax liens and tax deeds is relatively free from risks, and that is one of the calling cards of these investments; yet, they are not without some issues that you must be aware of.

Accumulated Tax Debt

There are certain situations in which tax debt will accumulate on a property which you can get caught up in. This is common with owners who repeatedly let their property go into tax default, never resolve, and which keeps accumulating 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 accumulated tax debt 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.

Junk Property

If you don’t adequately research the property you are bidding on, you may end up with something that has no value and you don’t really want. That equates to not being able to get your money back out.

Here’s an extreme example: you invest in a tax lien for what was at one time a junkyard. The owners never redeem, so you never earn any interest. When it comes time to foreclose, you realize what you are dealing with and that there’s no real likelihood you’ll ever be able to resell that parcel even if you acquire it for the amount of back taxes that your winning bid represents. Since it’s undesirable, it may be you never sell the property. In fact, that may be the reason why it ended up in tax default to begin with!

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, 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 bankruptcy, you never know how much that amount will be.

Bottom Line

Investing in tax delinquent property involves either tax liens or tax deeds, depending on location. Tax lien investing is mainly for earning above-market interest; tax deed investing is mainly about trying to purchase a bargain-priced property. During stipulated redemption periods, owners can reclaim their property, and investors will earn interest. Afterward, investors usually have the right to foreclose.