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Tax lien sale

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A tax lien sale is the sale, conducted by a governmental agency, of tax liens for delinquent taxes on real estate. It is one of two methodologies used by governmental agencies to collect delinquent taxes owed on real estate, the other being the tax deed sale.

Sale Process

In a tax lien state, the lien is offered to prospective investors at public auction. Most auctions are held in person; however, Internet-based auctions (especially within large counties having numerous liens) are becoming popular.

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:

  1. 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 (though this is rare in practice). 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. (Sausa 2006, pp. 36)
  2. Premium. Under this method, the investor willing to pay the highest "premium" (or excess above the lien amount) 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. (Sausa 2006, pp. 36)
  3. 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 (Larry Loftis, a professional tax lien investor from Orlando, Florida and an author on the subject, mentions in his book of a county that drew numbered ping-pong balls from a fried chicken bucket). (Sausa 2006, pp. 36)
  4. Rotational Selection. Under this method, the first lien will be offered to the investor holding number one, who has the right of first refusal. If the investor refuses, it is offered to number two, but 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 no control over which liens s/he will obtain in the bidding. (Sausa 2006, pp. 36)
  5. Bid Down the Ownership. Used only in Iowa, 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 redeemed, the investor would only receive 95% of the proceeds. In practice, few investors will bid on liens for less than full right to the property. Therefore, with multiple owners bidding on 100% encumbrance, the process then generally reverts to the random selection.

Liens not sold at auction are considered "struck" (or sold) to the entity (usually the county) conducting the auction. Some states allow "over the counter" purchases of liens not sold at auction. However, in most instances the unsold liens are on marginal or worthless properties, the liens on better properties having been purchased at auction.

Redemption Process

The investor must wait a specified period of time (referred to as the "redemption period"), during which time the property owner (or someone with an interest in the property) may repay the lien with interest. 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. (Sausa 2006, pp. 13)

In some jurisdictions, the lienholder must agree to pay subsequent unpaid property taxes during the redemption period in order to protest his/her interest. If the lienholder does not pay such taxes, a subsequent lienholder would "buy out" the prior lienholder's interest. (Sausa 2006, pp. 13)

Once the redemption period is over, the lien holder may initiate foreclosure proceedings. The proceedings (the costs of which must be paid by the lien holder, though a redeeming property owner may be required to pay them as part of redemption) may result in either acquiring title to the property (normally this will be a quitclaim deed and not insurable title), or a tax deed sale of the property where the lien holder has the right of first bid (and may participate by making additional bids if s/he so chooses). 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. (Sausa 2006, pp. 16)

If the lien holder does not act within a specified period of time as defined by state law, the lien is forfeited and the holder does not receive a return of his investment. Also, a lien issued in error of state law is repaid, but usually at a far less interest rate than had the lien been valid.

Hazards of Tax Lien Sales

The rates of return can be highly attractive. For example, Florida (a popular tax lien state due to its growth and investor-friendly rules) is a "bid down the interest" state with a maximum rate is 18%. (Further, it has a guaranteed minimum return of 5% regardless of the rate bid, except if the bid is zero percent.)

As such, this has spawned an industry of "experts" willing to sell their "knowledge" (often at highly inflated prices, and only available through their channels) to gullible members of the public, usually not explaining the pitfalls.

Pitfalls of tax lien investing

  • Payment is usually required at purchase or within a very short time afterward, thus requiring high levels of liquidity.
  • Tax liens on "choice" properties are quickly purchased by major institutional investors having sufficient time and resources to research valuable properties vs. worthless ones and who can afford the occasional poor choice; smaller liens usually involve properties that are generally worthless (such as odd strips of land). (In addition, Florida does not allow auctions or sales of tax liens of less than $100 on homesteads; thus, many liens are unavailable to average investors.) In "random" and "rotational" jurisdictions, investors have even less control over which liens they purchase.
  • In "bid down the interest" jurisdictions, valuable properties are usually bid to the lowest rate possible greater than zero percent. (For example, Florida permits the interest rate to be bid down to a minuscule 0.25%.) Similarly, in "premium" states, valuable properties are bid up above the means of an average investor.
  • Unlike a certificate of deposit, tax liens are illiquid. They cannot be "cashed in" (resold to the taxing authority), but must be held until either they are repaid or the holder takes action to foreclose. (It is possible, however, to assign one's interest in a tax lien.)
  • Some experts tout tax lien sales as a means of acquiring property at highly discounted prices. In practice, liens on valuable properties are paid well before the property can be foreclosed (especially where a mortgage is involved, as the mortgage holder is secondary in line to a tax lien), and where tax deed sales are used to foreclose, numerous bidders participate, thus making the chances of actual acquisition remote.
  • If someone is successful in attaining the deed to the property, the property might have environmental problems for which the new owner will be responsible. Depending upon the state, this could be very disadvantageous and the investor might have to pay a large amount of money to have the problem taken care of and/or be fined daily until the problems are fixed.
  • There may also be other governmental liens (such as weed liens or demolition liens) that the investor must pay off when attaining title to the property. These are not part of the lien sale and remain even if the lien holder acquires the property.
  • If the owner of the property declares bankruptcy, the bankruptcy court may lower the interest rate to be paid, or may discharge part or all of the lien, leaving the lien holder with nothing.

See also

References

  • Sausa, D. (2006). Investing Without Losing: The Beginner's Guide to Real Estate Tax Lien and Tax Deed Auctions, 1st edition. The Vision Press. ISBN 0-9788346-0-7
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