A tax sale is the forced sale of property (usually real estate) by a governmental entity for unpaid taxes by the property's owner.
- Tax deed sale
- Pitfalls of tax deed investing
- Tax lien sale
- Popularity of tax lien sales
- Pitfalls of tax lien investing
The sale, depending on the jurisdiction, may be a tax deed sale (whereby the actual property is sold) or a tax lien sale (whereby a lien on the property is sold) Under the tax lien sale process, depending on the jurisdiction, after a specified period of time if the lien is not redeemed, the lienholder may seek legal action which will result in the lienholder either automatically obtaining the property, or forcing a future tax deed sale of the property and possibly obtaining the property as a result.
The governmental entity can be any level of government which can assess and collect property taxes or other governmental debt, such as counties (parishes, in the case of Louisiana), cities, townships (in New England and other jurisdictions), and school districts (in places where they are independent of other governmental jurisdictions, such as in Texas).
State law offers the governmental entity a method of collecting its tax without simply having to "ding" the nonpaying person or business, by (after a specified grace period, whereby the property owner can be charged interest and/or penalties as well as other costs) placing a lien on the property which, if not paid, will result in future costs, and ultimately the property being seized and sold. In most places in the US, a tax lien takes priority, eclipsing other liens such as mortgages.
The requirements to begin the foreclosure process (and to avoid it) must be strictly followed; otherwise, the property owner will lose all rights to the property (or the governmental entity will lose its right to collect the outstanding debt). Common requirements include:
Once the process begins, the property owner can still avoid foreclosure by paying the amount owed plus interest, penalties, and/or other costs or fees. The amounts can end up being quite high once the process is well under way. Even after foreclosure, in some jurisdictions the owner can still recover the property, by paying the amounts owed (plus additional interest/penalties/costs) within a specified time. Alternatively, the owner can file suit to have the sale set aside on grounds that the requirements were not followed (such as proper notice not given).
Two main methods are used to capture delinquent real property tax: the tax deed sale and the tax lien sale.
Both methods operate using an auction method. Traditionally, the auctions have been live events held at the county courthouse or another designated official location. However, online auctions have increased in usage.
Tax deed sale
In a tax deed sale, the property itself is sold.
At the sale, the minimum bid is generally the amount of back taxes owed plus interest, as well as costs associated with selling the property. The purchaser making the highest bid for the property takes title. However, the purchaser usually has a very short period (generally 48–72 hours) to pay the entire amount owed, or else the sale is invalidated.
Depending on the jurisdiction, any amount in excess of the minimum bid may or may not be returned to the original property owner, or the owner may forfeit rights to such excess amount if not claimed within a specified period. Also, anyone having an interest in the property (such as a governmental entity having weed liens on the property) may, in some cases, claim the excess.
In the event the property is not purchased at auction, title generally reverts to the governmental entity that initiated the sale, which can then offer it for at or even below the original minimum bid (depending on property value and/or interest in the parcel).
Title is generally transferred in a tax deed sale through a form of limited warranty or quitclaim deed (sometimes styled as Tax Deed or Sheriff's Deed). In most jurisdictions, this type of deed is generally insufficient to acquire title insurance. Therefore, a purchaser would most likely then need to initiate a quiet title action in order to resell the property later. However, the property can be sold from one purchaser to another using a limited warranty or another quitclaim deed, though usually at far less than its market value.
Some jurisdictions allow for a post-sale "redemption period," whereby the former owner has a specified amount of time to reclaim the property by repaying the amount bid at auction plus interest, penalties, and/or other costs. As such, purchasers of properties at tax deed sales are cautioned not to make major improvements on the property until after the redemption period has expired, as such improvements would then become the property of the original owner.
A tax deed sale may also be used in conjunction with a tax lien sale process, whereby the lienholder (instead of a governmental agency) starts the process toward forcing a public sale of the property. In those instances the lienholder's investment (the price of the lien plus any additional costs necessary to start the tax deed sale process, such as required fees and payment of any still-unpaid taxes or buyout of other certificate holders' interests) constitutes the minimum bid; if no other bids are received at the sale then the lienholder will take title to the property subject to redemption periods (if applicable) or any lawsuit to overturn the sale.
Pitfalls of tax deed investing
Although the possibility of obtaining property at rates far below marked values is promising, there are several pitfalls which must be taken in to account before investing:
Tax lien sale
In a tax lien sale, instead of selling the actual property, the governmental entity sells a lien on the property. The lien is generally for the amount of delinquent taxes, accrued interest, and costs associated with the sale.
In the event that more than one investor seeks the same lien, depending on state law the winner will be determined by one of five methods:
- 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. The investor accepting the lowest rate of return is the winner. In the event that more than one investor will accept the same lower rate, the tie may be broken by 1) first bid received, 2) random selection, or 3) rotational method (see below for further discussion of the latter two methods). (States that use this method include Arizona and Florida)
- Premium. Under this method, the investor willing to pay the highest premium (excess above the lien amount) will be the winner. The premium may earn interest at a different rate than the base lien value (or may not earn interest at all), and in some cases may not be paid back to the investor upon redemption of the lien. (States that include this method include Colorado; Colorado does not pay interest on the premium nor does it return it upon redemption)
- 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. (States that use this method include Nevada)
- 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. 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 a tiebreaker method such as random selection. (States that use this method include Iowa)
Liens not sold at auction are considered "struck" (sold) to the jurisdiction conducting the auction. Some jurisdictions allow "over the counter" purchases of liens not sold at auction, subject to some liens being exempt from sale.
The investor must wait a specified period of time (commonly referred to as the "redemption period") before taking action to foreclose on the property. During the redemption period, the lien (plus interest and any other fees) may be repaid by the owner or a legal designee of the owner. Usually the lien holder is not permitted during this period to contact the property owner (or anyone else having an interest in the property, such as the mortgage holder) to demand payment or threaten foreclosure, or else the lienholder can face sanctions (such as: termination of the lien and loss of money spent, being banned from future sales, and/or criminal charges).
In some jurisdictions, the lienholder must agree to pay subsequent unpaid property taxes during the redemption period in order to protect his/her interest. If the lienholder does not pay such taxes, a subsequent lienholder would "buy out" (redeem) the prior lienholder's interest. Other jurisdictions allow the lienholder first right to pay subsequent taxes, but if the lienholder chooses not to do so, a separate lien is offered for sale. Still other jurisdictions do not offer subsequent tax payment priority; each lien is sold separately (and can result in multiple liens on a property held by different lienholders).
Once the redemption period is over, the lien holder may initiate foreclosure proceedings. Normally, the cost of the proceedings will include, in addition to statutorily-mandated costs (such as application fees and costs for public notices), buy-outs of other liens and payment of any other unpaid taxes plus accrued interest. During the period between the initiation of proceedings and actual foreclosure, the property owner still has the opportunity to repay the lien with interest plus the costs incurred to foreclose.
The foreclosure proceedings, depending on the jurisdiction, may be either:
In both cases, as with tax deed sales, title to the property will normally be in the form of a quitclaim deed, thus requiring further action to quiet title.
If the lienholder does not act within a specified period of time, as defined by state law, the lien is forfeited and the holder loses his investment. This period of time cannot be extended unless the tax lien holder is officially in the process of foreclosing on the property or other legal action (such as bankruptcy) is pending.
A lien issued in error of state law is repaid, but usually at a far lower interest rate than had the lien been valid.
Popularity of tax lien sales
The popularity of tax lien sales is driven, in large part, by the maximum rate of returns offered, which can be far higher than other investments, as well as the guarantee that the governmental entity, if the lien is redeemed, will repay the investor. Examples of such high returns include:
The market in tax liens has been so popular that a number of major banks and hedge funds have invested large amounts of capital in it.
Pitfalls of tax lien investing
Although the rates of return are promising, there are several pitfalls which must be taken in to account before investing: