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Tax Sales

A Straightforward Tutorial on Tax Lien Sales, Tax Deed Sales, Tax Foreclosures and everything in-between.

What are Tax Sales?

There are two ways to make money with tax sales: Tax Lien Sales and Tax Deed Sales.  A tax lien sale is the sale of back taxes owed on a specific property.  A tax deed sale is the sale of a property’s deed due to a failure to pay off back taxes and/or tax liens.   What does that mean for you?  It means that you now have the potential to make a smart investment and receive a significant amount of money. 

Why are tax sales such a smart investment?  Just by reading the previous paragraph you know more about tax sales than the overwhelming majority of people in America.  And that advantage is just the tip of the iceberg. 

The true benefit of tax sales can be measured in the interest rates – 16%, 24%, and 36%.  Those numbers are the respective annual interest rates on tax liens in Arizona, Iowa and Illinois.  To give you some comparison, you would be lucky to receive 2% interest on a high interest savings account.  To give you an idea of how much money that is over the course of a year – with a $5,000 investment you could be making at least $700 more per year with a tax lien investment in Arizona, than with a 2% interest rate at your local bank – the equivalent of several months worth of car payments. 

And while you are thinking about the interest rates, know that these rates are only the beginning.  You can, on occasion, nearly double your investment in a few short days.  How?  Well, people who don’t pay their taxes usually don’t pay their mortgages either.  Therefore, if the mortgage holder was to foreclose on the property, and you have just bought a tax lien on the property, the mortgage holder would have to redeem the tax lien.  This means that you will receive value of the lien plus what the interest would have been at full maturity – a staggering amount of money in a short amount of time, if a mortgage foreclosure happens soon after you have purchased the tax lien.  That means in Iowa you would receive 42% on top of the cost of the tax lien (21 month redemption period at 2% per month).  And that is just tax liens.

Slightly more expensive, you could buy a Tax Deed, giving you a property – for as little as 20% of its assessed value.  Of course some states allow a right of redemption, but you will still receive a return on your investment.  In Texas that rate of return is a 25% penalty placed upon the delinquent property owner.  Think about that for a second – even when you lose, you still win.  You may not end up with the property, but you still end up with a significant return on your investment. 

You may be asking yourself, why would the local government or county sell tax liens and tax deeds?  Well, they want to get paid, and selling tax liens and tax deeds allows that to happen.  What makes this noteworthy is that in almost all circumstances the lien and/or deed is guaranteed by the local government, ensuring that even in a down economy you will have made a wise and sound investment. 

Now do you understand why tax sales are so lucrative?  The relative obscurity of how to participate in tax sales, gives you the ability to make smart investments, and their comparatively high interest rates allow you to make a significant amount of money.  And the risk factor is minimal because in almost all circumstances the lien and or deed is guaranteed by the local government and/or county.  While all of this is true, there are some pitfalls to watch out for.  Therefore in this article we will explain to you the ins and outs of tax sales – specifically Tax Liens and Tax Deeds and how to put yourself in the best position to make a successful investment. 



How Do Tax Lien Sales Work?

What are Tax Liens? 

When a property owner fails to pay property taxes for a specific amount of time, a tax lien is filed against him or her by their local government or county.  The local government or county then sells the lien – at auction – to an authorized third party, who in turn collects on the lien, which is the taxes owed which is often a substantial interest.  The tax lien purchaser can make a significant amount of money in as little as a few days.  The tax lien purchaser also buys the right to own the property if the delinquent property owner fails repay the lien amount plus interest within a specific amount of time.   

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The Payoff – What You Can Expect to Accomplish

            With tax liens, you can make a significant amount of money in short amount of time due to the high interest rates on tax liens (New Jersey offers 18% per year for a two year period, plus an additional penalty of up to 6%). The exciting part is that if a bank forecloses on the property within the tax lien repayment period, they will pay you the cost of the lien plus interest at full maturity.  In other words: Mr. Sanders purchases a Tax Lien Certificate in Illinois worth $10,000, with the full 36% interest rate, and the bank forecloses on the property the following day.  The bank will pay Mr. Sanders $19,000 – what the lien plus interest would have been at full maturity or 36% a year times 2½ years.  In this situation, Mr. Sanders would make $9,000 – almost doubling his investment in a single day. 

            Purchasing a tax lien gives the purchaser the right to own the property, if the lien is not repaid.  In that situation, the property would have been bought for just the taxes owed.  So, if the tax lien owned by Mr. Sanders has not been repaid after two-and-a-half years, he will now own the property for just $10,000 – his initial investment.

The risk on tax liens is very low for four main reasons: (1) state and local governments control the tax lien process, ensuring stability; (2) property owners risk losing their property if they do not repay the lien with interest; (3) in most states you receive the property if the delinquent owner does not repay the lien plus interest; (4) the value of a tax lien is not affected by the economy (unlike the stock market).  In fact, a poor economy usually means that more people fail to pay their property taxes, enhancing the amount of tax liens available. 

Investing in tax liens is something that very few people understand.  Every year there are thousands of tax lien sales.  And when these sales happen, there are usually hundreds of liens available, giving you a great chance to find a valuable investment at an extremely discounted rate. 

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The Payoff – What You Can Expect to Accomplish

This is where the money is made.  For example, in Illinois, the interest rate ranges from 18%-36% a year, with a two-and-a-half year redemption period.  Additionally, if the bank or local government were to foreclose on the property, the lien holder would be eligible to receive full maturity on the lien.  So say for example, Mrs. Jefferson would purchase a Tax Lien Certificate in Arizona worth $10,000 and the bank or local government were to foreclose on the property the following day, they could be obligated to pay Mrs. Jefferson $11,600 – the cost of the lien at full maturity. 

However, if the property owner would fail to pay the lien back, and the bank or local government failed to foreclose on the property, the third party may be able to file a lien foreclosure, which can lead to a Tax Deed Sale (which you can read about here). The property owner and all possible lien holders have been informed of the legal implications of their failure to pay property taxes. The tax deed sale will usually result in either the property being transferred to the third party directly, or would give the property owner the right to make the first bid on the property. 

A Tax Deed Sale is a public sale, usually at auction. More importantly, the now owner of the property after the lien foreclosure/tax deed sale, owns the property free and clear.  All other liens are usually wiped out – property taxes take precedent, because the government wants to be paid – and any mortgages no longer use the property as collateral.  What this means is that you would most likely own the property free and clear; however, it is best to check with local officials to ensure that the original property owner has no right of redemption. 


Preparing for the Auction?

Once you have done your initial research, it is time for the auction.  Some local governments and counties still follow the traditional method of holding auctions in person, while others have started holding auctions online.  It would be smart to attend pre-auction seminars that are offered, as well as other tax lien auctions to see how they run, before you invest, so that you can properly plan your investment strategy. 

Some local governments and counties require a pre-registration for the auction – so be informed of the auction’s specificities and be sure to be on-time.  Do not forget to bring at least two forms of identification (at least one should be a government issued identification such as a driver’s license or passport).  Sometimes, liens that are not sold at auction can be purchased on a first-come, first-serve basis – speak with local officials to find out how and where to do so.   


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The Tax Lien Auction

Different municipalities use assorted auction methods to dispose of tax liens that more than one person is interested in. There are essentially five chief ways a lien is bid on: 

(1) Bidding 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.  The investor accepting the lowest rate of return is the winner. In the event more than one investor will accept the same lower rate, a random or rotational method (see below) will be used to break ties.
(2) Bidding a Premium on the Lien.  The investor willing to pay the highest premium (the lien amount plus a premium) on the lien will be the winner. The premium may or may not earn interest, and may or may not be paid back to the investor upon redemption of the lien, it is best to speak with a local real estate attorney regarding this matter. 
(3) Random Selection.  With this process a bidder will be randomly selected from those offering bids – usually through a computer.
(4) Rotational Selection (used to break a possible tie in bidding down the interest).  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, and so on.  With this type of auction, investors have little control over what liens they will obtain. 
(5) Bidding Down the Ownership of the Lien.  Under this method the winning bid is awarded to the bidder willing to purchase the lien for the lowest percent of encumbrance on the property. For example, a bidder may agree to take a lien on only 85% of the property. If the lien is not redeemed, the investor would only receive 85% ownership of the property with the remaining 15% going to the original owner.

This is why it would be best to avoid bidding wars.  You could theoretically end up with a lien that can become more of a nuisance than an investment.  An investment that only promises a small rate of return may not be worth the hassle.

Of course, all of this information is worthless if you don't first doing your research and then come on time for the auction. 

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 Strategies for Tax Lien Investment

Research the list of delinquent properties.  Most states and local governments offer listings of tax liens and tax sales that can by checking the GovernmentAuctions.org website often.  Check GovernmentAuctions.org often for upcoming tax lien and tax deed sales in your area, because most local governments and counties hold tax sales only once or twice a year.    

When you get a list of properties from GovernmentAuctions.org, you should begin researching these lists to find good properties – ones without environmental issues, or other problems.  Once you have found a property you are interested in, you should assess the property value.  How much is the property worth?  Even though you will probably avoid having to foreclose on the property, knowledge of the property is important if you do end up with the property. 

Once you have registered the winning bid, you must pay within 72 hours.  Failure to pay for the lien certificate will result in a cancellation of the certificate, a loss of your deposit and a possible exclusion from any future tax sales. 

The purchaser also needs to be aware of any additional steps or requirements that need to be taken following the purchase a lien certificate.  For example, some states, like Arizona require that the lien certificate holder pay property taxes until the lien has either been paid off or redeemed (the property taxes paid by the holder, are added to the lien amount).  Failure to pay property taxes can result in either a cancellation of the tax lien certificate or the loss of tax lien priority at the next tax sale when a new tax lien is put up for auction – taking away your ability to receive the property if the delinquent owner fails to pay the lien.  Most importantly, do not forget to record your lien with the local property clerk’s office (If you are unsure how to do so, speak with a local real estate attorney who could point you in the right direction), otherwise you may lose your lien on the property. 

A Tax Lien certificate holder must also be aware that they cannot sell their lien certificate at any time.  While interest in the lien can be assigned, it is best to speak with an attorney prior to doing so. 

The complexity of tax liens requires you to do research on the laws of various states.  Do not be afraid to speak with a local attorney to better understand these laws, and obligations. It is this knowledge that will ensure that you are put in the best position to succeed. 

Final Thoughts on Tax Lien Investing

This whole process requires you to be smart, and use common sense.  Avoid pitfalls – know the problems and how to overcome them.  Don’t just go into an auction and bid on the first property that comes your way.  Do your research, and know which properties are the ones that you want.  Sometimes the best investment you can make is to hold onto your money and wait for the next property.  It is a good idea to speak with a local Real Estate Attorney prior to auction, to ensure that you understand all of your obligations, as well as the local rules and regulations governing the property. Be smart with your money, know your risks, know your intent and use common sense.  Following these steps will ensure that your tax lien investing experience will be a rewarding experience.

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How Do Tax Deed Sales Work?

What are Tax Deed Sales

A tax deed sale is where a local government or county has foreclosed on a delinquent property owner and has received title to their property.  The local government or county then sells the tax deed at auction – allowing the winning bidder to obtain property ownership at a discounted price (sometimes for as low as 20% of its assessed value). 

Some local governments and counties allow a delinquent property owner a right of redemption – a chance to reacquire their property.  Even in this situation, you would come out ahead.  You will receive the amount of money you bid at auction plus interest.  For example, Texas requires a flat 25% penalty to be added to the amount paid at the sale.  If Mr. Sanders were to purchase a tax deed in Texas for $10,000, and the delinquent owner redeemed the property two weeks later, Mr. Sanders would have made $2,500, in just two weeks.  

Additionally, in most situations you can use the property during the redemption period.  For his $10,000 investment, Mr. Sanders can rent out the property for $1,000 a month, and receive a full return on his investment in less than a year.

Being an obscure way of investing, tax deed purchasers benefit from the relative anonymity of tax deeds.  For as many people understand tax lien sales, fewer understand tax deed sales.  Therefore, knowing the ins and outs of tax deed sales, grants you the potential to make a significant amount of money. 

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Preparing for the Auction

 It is very important to know how tax deed auctions run. Go to a few auctions and see how they run before you invest. Some auctioneers run pre-bidding seminars, free-of-charge, allowing you to ask questions, and find out the specifics of the bidding process.  If you can, attend these seminars – you will have a better understanding of the auction process. 

Awareness of who shows up the auctions is also important.  Are they investors like you, or are they banks looking to ensure that they receive a full return on their investment.  Knowing these issues can help you identify the costs associated with obtaining a tax deed helping you go a long way towards evaluating and planning your investment strategy. 


The Tax Deed Auction

Unlike a tax lien sale, a tax deed sale is a straight-forward auction.  The person with the highest bid wins.  The bidding starts at the amount back taxes owed plus interest, as well as costs associated with selling the property.  For example, Mr. Davis owes $1,000 in back taxes plus interest, and it costs the local government $500 to sell the property.  The bidding would start at $1,500, and depending on the jurisdiction, the property would be bid up between $10 and $100 at a time.

Also be aware that you must pay for the tax deed within 72 hours.  Therefore, be sure to have the necessary capital, or financing lined up prior to the auction.  Some local governments, such as New York City, will sometimes offer mortgages, to assist with payment (but only to qualified buyers), therefore you should speak with the local government, as well as possible lenders, prior to auction to ensure that you will be able to purchase the property. 


Tax Deed Property Investment – Knowing the Property

By law, tax deed sales must be announced to the public – allowing potential investors to do the necessary research.  Therefore, it would be a good idea to check GovernmentAuctions.org often for upcoming tax deed sales in your area, because most local governments and counties hold tax sales only once or twice a year.   

When you get a list of properties, you should begin researching these lists to find the types of properties you want to invest in.  Do you want to invest in open lots, commercial space, or residential space?  Once you know what type of property, you can then look to the specific locations of the property. 

You may not want to buy a residential property in the middle of an industrial park, so it is best to know where the property is located.  If you want to invest in a certain area, make sure that the property you plan on bidding for is worthwhile.  If, for example, the property is landlocked or contains an environmental concern it may be best to avoid purchasing it. 

Some local governments and counties offer open houses prior to tax deed sales. Much like a test drive, it would be a good idea to attend the open house, because properties are offered as-is.  If there are any problems with the property, it would be your responsibility to deal with.  Therefore it would be wise to bring along a contractor and/or an inspector to help assess any problems with the property, and help estimate a cost to help fix up the property. 

Before you attend the open house you should check with the local code enforcement office to find out what, if any code violations exist at the property, to make sure that the property is even worth considering.  Finally, you may want bring along an appraiser to ensure that any bid you place on the property will be a smart one.

Properties go into tax deed foreclosure for a reason.  Find out why.  Knowing the geographical location can only tell you so much when assessing the fair market value.  Check with the local zoning officer to find out the property’s permitted uses.  And if possible, speak to the neighbors – they will be more familiar with the property and may know much more than any public official.      

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Possible Problems

If you find that there are problems speak to a real estate attorney to help you navigate the legal issues.  They know the local laws and can help you if any problems arise with the property.  They can also help you dispose of any personal property left behind, such as clothing, furniture, and other personal items.  A lawyer can also assist with eviction proceedings, if necessary and most importantly help you record the deed with the county clerk’s office, enabling you to start using the property as soon as possible.  An attorney can also assist you in obtaining a free and clear deed on the property. 

Final Thoughts on Tax Sale Investing

Doing your research on the properties is just the beginning.  As with any investment, careful planning will ensure that your risk is kept to a minimum.  Remember to be prepared – do your research, know how much you are willing to spend, and most importantly use common sense.  This article is just a guide towards beginning your investment process.  If you follow the above advice and tread carefully then you can find tax deed investing to financially be a wildly rewarding experience.

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