Liens, Deeds, or Redeemable Tax Deeds?

In the United States, property tax must be paid by property owners on an annual, semiannual, or quarterly basis. Every county (or other municipality) needs and MUST collect property tax to fund municipal budgets/programs such as fire stations, police stations, public libraries, schools, parks, and roads. Many property owners, especially during the economy of the last several years, are often delinquent in paying their property taxes. The counties generally try to work with the property owners as much as possible, but it doesn't change the fact that they need to collect the property taxes whether it is from the property owner or from an outside investor. To obtain that money, the counties place tax liens on delinquent properties. The process for how the tax lien is paid for and abolished varies state to state. Each state uses either tax lien certificates, tax deeds, or redeemable tax deeds as the delinquent tax collection method. Each of these methods are described below.

Tax Liens

After a property owner fails to pay their property taxes for a certain period of time, a tax lien is created and placed on the property. If a tax lien "goes to sale", third-party investors have the opportunity to purchase a tax lien certificate, with the benefit being a nice, fixed-rate return on their investment when the property owner redeems (pays for) the property. Below is a typical sequence of events that occur from the establishment of a tax lien to the redemption of a tax lien:

1. Property owner doesn't pay their property taxes on time and is usually hit with a late payment penalty.
2. The county sends the property owner one or more notices about being late and informs the property owner that a property tax lien may be placed on the property if the property taxes are not paid by a specific date.
3. If the "specific date" passes, and the property owner has still not paid the property taxes, the county places a property tax lien on the property. A tax lien on a property can be considered an official warning that the property is subject to an eventual tax foreclosure. The time and process with which a property is foreclosed upon varies by state.
4. In a tax lien state, all property tax liens are added to an inventory of tax liens to be sold by the county at a public or online auction. In a tax deed state, property tax payments must be delinquent one or more years before they are subject to a tax deed sale or directly deeded to a government entity. If a property is foreclosed upon and deeded to a government entity, that entity can either keep that property in inventory, resell the property at a public auction, or resell the property "over-the-counter".
5. The tax sale list of properties is advertised in the classified section of local newspapers and is often posted on the county's Web site as well. The information on a list of properties will vary, but usually includes the physical address and/or property ID, the owner name, and the minimum bid amount. Tax sale lists can also be viewed at the county office or obtained by mail from the county (usually for a fee).
6. The tax lien is sold to the highest/best bidder at a public or online auction. The frequency and bidding methods of public tax lien sales vary by state and by county.
7. By buying a tax lien, the real estate investor is essentially paying the property taxes for the property owner. The investor pays this money directly to the county office and has no interaction with the property owner. Starting from the date of the tax lien purchase, the investor can earn a fixed interest rate and/or flat penalty on the tax lien "certificate". The annual interest rate or flat penalty earned by the investor varies by state and by county, but generally range from 9% to 25%.
8. After a few weeks or several months, the property owner may pay their delinquent taxes plus penalties and interest to save their property. This is also referred to as "redeeming the property."
9. After receiving the money from the property owner, the county then mails a check to the investor. The check covers the investor's initial investment plus all interest earned on the tax lien certificate.

Factors Determining the Interest Rate on a Tax Lien Certificate

The interest rate or yield on investment is influenced by the following factors:

• The state's mandated interest rate (and/or flat penalty rate) terms or guidelines. Each state that sells tax liens or "redeemable" tax deeds (explained below) has a base interest rate and/or flat penalty rate that is assessed on the property tax bill when it is finally redeemed by the property owner.
• The bidding type used at the auction and the result of the sale. There are a few other bidding types as well, but the two main bidding methods used at tax lien auctions are Premium and Bid-Down Interest. For more information on auction bidding methods, see the Auction Bidding Methods article.
• The time that elapses between the date of the tax lien certificate purchase and date of redemption. Most states use a per annum (annualized) interest rate. If the interest rate on the tax lien certificate is 18% (equivalent to 1 ^1/2 percent per month), and the property owner pays the back taxes after 6 months, your actual return is 9% ( 1 ^1/2 % x 6 = 9%). If the property owner pays the back taxes after 18 months, your actual return is 27% ( 1 ^1/2 % x 18 = 27%)! Some states use flat "penalties" instead of accruing interest. A flat penalty is generally bad for the property owner, but good for the investor. If you invest in a state that uses a flat penalty, the best scenario is for the property owner to redeem as soon as possible because interest accrual is no longer a factor. A flat penalty is assessed on the tax lien amount regardless of when the investor pays the tax bill. You get the same return whether the property owner redeems the next day or six months from the date of the sale. This leads to incredible returns!

Foreclosing on a Tax Lien Certificate

There is also a chance that you'll get the property when you purchase a tax lien certificate. Each state has a redemption period in which the property owner must pay their back taxes or risk losing their property. A redemption period is essentially the period of time between the county's first attempt at selling the tax lien at a sale (whether it was purchased or not) and when the county or tax lien holder can start the home foreclosure process on the property owner.

And this may be the best part....

A property tax lien is a first order lien which takes precedence over virtually^* all liens and encumbrances on the property! This includes all mortgages on the property! What this means is that it is possible to acquire the property "free and clear" and the existing mortgage is wiped out!

* IRS liens and environmental liens generally take precedence over property tax liens. The good news is that these type of liens are fairly rare, and the counties are generally obligated to disclose this information prior to a sale. In New Mexico and Arizona, state-level liens can take precedence over property tax liens.

Tax Deeds and Redeemable Tax Deeds

The purchasing of tax deeds is a little different than tax liens, but the general concept and process is the same. When you buy a tax deed at an auction or directly from a county "over-the-counter", you are actually buying the property, usually at a huge discount compared to the market value. Tax lien and tax deed states are split about equally in the United States. In a tax deed state, the counties still place tax liens on properties, but they do not make these tax liens available for public sale. Instead, tax deed states wait until a property owner is about a year or more delinquent on their property taxes, at which time they notify the property owner that they will be selling the tax deed to their property at a public sale unless they receive payment from the property owner before the sale occurs. In traditional tax deed states, the former property owner has no opportunity to redeem the property once the tax deed is sold. In "redeemable" tax deed states, the former property owner is given a redemption period in which to redeem the property. During the redemption period, interest and/or penalties accrue. If the former property owner is able redeem the deed, the tax deed purchaser "loses" the property but receives a handsome return in interest.

States that Sell Tax Liens and Tax Deeds

There are several states, including Alabama, Florida, New York, and Ohio that sell tax lien certificates and tax deeds. In Illinois and Indiana, both tax liens and tax deeds are sold, but the tax deeds are sold by third-party organizations, and not directly by the counties. See the summary page for these states for more information.