Paying the back taxes on a piece of property can enable savvy investors to make a good return by actually taking possession of the property or by financing the tax lien itself and profiting from the property owner’s making good on that debt.
A tax lien gives the government body -- whether it’s a village, county, state, or federal government -- the right to seize property in lieu of unpaid taxes. But there are big differences in how that’s resolved.
Of course, the debt can be paid and satisfied by the property owner. But if not, real estate investors can invest in that property themselves through public auction. But you need to know the difference between a tax lien sale and a tax deed sale.
Only one gives you ownership of the property.
A tax deed sale is a sale, indeed. A tax lien sale, more an investment.
That first method we’ll discuss is a tax sale. That occurs when the property tax has not been paid for a long enough period of time that the tax collector -- usually a county but that can vary from place to place -- slaps a tax lien on it and eventually puts it up for sale if the lien is not satisfied.
A tax deed sale gives the winning bidder ownership of the property.
Then there’s a tax lien sale, which grants the winning bidder a tax lien certificate, entitling them to pay the back taxes themselves in return for collecting the unpaid taxes, interest, and penalties from the property owner.
The ownership remains with the property owner, unless it otherwise ends up in foreclosure or is sold.
(Neither of these are the same as a sheriff’s sale, which is a public auction of repossessed and/or defaulted properties -- real estate or personal property -- at the end of the foreclosure process.)
Some other things to know about a tax deed sale
This is the local government lien-holder doing the same thing as a lender would in a foreclosure: selling the property and using the proceeds to pay off the tax lien or liens (the IRS and state could be involved, too).
By law, a tax sale must be advertised publicly, so don’t expect to be the only person in on the game. You also must be able to pay cash, usually within 24 hours of winning the bid, and you usually can do no more than take a look from the outside.
"More often than not, you can’t even go in the house at all until after you’ve purchased it. This is the single biggest reason these types of homes sell for 30% to 50% less than their peers: only an idiot would pay as much for a house they can’t inspect as one they can," says this blog on MoneyTalksNews.
Also, be aware of the need to check for other issues surrounding the property before you submit a binding bid. For example, there could be other liens -- from contractors, lenders, government bodies -- that could cloud ownership of the property and won’t be apparent without some research either by you or a professional title search firm.
How do you find tax-delinquent property for sale?
Your local property tax collector, the governmental entity that put the tax lien on it, maintains the list of who it taxes, how much, and the status of the taxes owed. That information is public record and typically contains at a minimum:
· The address.
· The owner and date of purchase.
· How much the owner paid for the property.
· The appraised value.
· How much is owed on taxes.
· The status of the property (under lien, in foreclosure, etc.).
Public notice requirements provide that property tax sales be advertised for a specified period of time prior to the actual sale.
Back in the day, local newspapers were the main source to see notices of property tax sales (and were a big source of income, especially for small daily and weekly publications who ran those long lists of small type in the classified ads).
Public records like that now are usually accessible online for free (here’s an example from Union County, N.C., just east of Charlotte), but you can also save yourself some effort by using services that charge you for the information but can make it easier than wading through digital bureaucracy. Some examples are from DataTree and TaxLiens.com.
Buying a tax lien
Along with buying the property outright, you can also invest in tax liens. What happens here is that you actually buy the liens at auction, pay the back taxes, and, in return, receive the right to attempt to collect that money plus interest from the property owner.
According to the National Tax Lien Association (NTLA), rates vary by state. For example, there's a maximum of 18% in Florida, a fixed rate of 12% in Alabama, and 2% per month on the unpaid balance in Iowa.
"It is important to point out that the interest applied to tax certificates is simple interest. Further, in those states where 'bid down' auctions are the rule, it is rare to secure tax liens at the maximum rate allowed by statute. This is due to the highly competitive nature of the tax sale process," the NTLA says.
The NTLA says about 2,500 local jurisdictions now sell public tax debt. That’s a lot of places, but they’re not in all states. South Carolina, for instance, doesn’t permit them, so what you’re buying at auction is an interest in the land -- interest in a tax deed -- rather than a tax lien.
Investors in such sales usually get 3% to 12% in interest or end up with the tax deed outright, according to this blog from the prominent Palmetto State law firm of Haynsworth Sinkler Boyd.
But that blog also contains three caveats for potential tax lien (or tax deed) buyers:
· The IRS. A federal tax lien on real estate (or personal property) lasts for 10 years unless refiled and could continue after the property is sold.
· HOA obligations. Unpaid dues for maintenance and improvements are generally contractual and binding, and they can be yours to pay after the tax deed is recorded.
· Superfund liens. Current owners can be held responsible for their share of the cleanup of contaminated sites, and nearly 70% of that cleanup is paid for by Superfund liens.
What else should investors know about this process?
Whether you’re buying a tax lien or a tax deed, you’ll be competing against a lot of individual investors and institutional investors.
As this Washington Post real estate blog points out, hedge funds have been buying by the thousands properties nearing foreclosure, and lenders can be expected to jump in to hold on to their mortgage rights.
"There are so many people trying to do what you want to do that we hesitate to say that you should jump into this business. To do this successfully you really have to understand the ins and outs of real estate, real estate taxes, tax sales, foreclosures, sheriff sales, redemptions, and a host of other real estate topics," the Post’s real estate writers advise.
But if you do understand these realities already or can learn to without incurring too much financial damage -- consider attending some auctions just to learn before jumping in –--you can come out ahead while helping make sure those property taxes eventually get paid. They do, after all, finance things like police, schools, and roads.