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Tax Lien Foreclosure: What is it & How it Works

Tax Lien Foreclosure: What is it & How it Works

Billions of dollars in property taxes go unpaid every year, a major problem for local municipalities that depend on this money to fund public services. Instead of waiting months or years to pay unpaid bills, the county treasurer imposes a tax lien on the property. Failure to pay the lien for a certain period can ultimately lead to property forfeiture through a court process called a tax lien foreclosure.

While foreclosure's complexity varies from state to state, it can generally be a valuable way for real estate investors to buy small discounted properties or earn a passive return. In this piece, we covered how a tax foreclosure works, the risks and rewards associated with this method of real estate investment, and what you need to know before investing/buying a tax lien or getting involved with a tax lien foreclosure.


What is a tax lien?

A tax lien certificate is issued when an owner does not pay property taxes. The tax lien serves as a public claim for the tax collector's right to collect unpaid property tax before the property can be sold or transferred. Many cities choose to sell the tax lien certificate through a public auction called the tax lien sale. This sale gives the right to collect the unpaid tax from the collector to the successful bidder. The buyer receives a return rate based on the purchase price earned through various commissions and accrued interest. Many states impose high-interest rates (up to 18% or more), but investors rarely get that return. The actual return rate is based on the amount the bidder will pay, or the lowest return they are willing to accept, which in most states ends up being between 2% and 5%.


How does a tax lien foreclosure work?

Suppose the tax lien remains unpaid for a certain period. In that case, the certificate holder or the regulatory body has the right to obtain ownership of it by applying the tax lien certificate, which is a legal procedure that allows the certificate holder to obtain the negotiable title property. The application process will vary from state to state but requires the insurance holder to deliver a service to all interested parties while waiting for a delay for the parties to respond to the action or reimburse the unpaid taxes. If there is no response and the time limit expires, a sentence is pronounced, and the employer can continue the enforcement, possibly obtaining ownership of the property.

A tax lien foreclosure is one way by which lien holders can recover the money owed to them. Implementing the tax lien will differ from state to state and from municipality to municipality, which means that investors wishing to pursue this investment route should understand the implementation process of their local tax lien.

It is essential to note that while tax lien and tax documents have similar sales processes, they are not the same. A tax lien foreclosure is the statutory process used by states that only issue tax liens. A tax deed is sold through a public auction, which transfers ownership to the winning party, but requires additional legal action to have a clear and negotiable title. Of the 50 states, 15 currently only issue tax rights, 8 offer a combination of tax rights and tax documents, and 27 only use tax documents. A hybrid state will first issue a withholding tax certificate. After a while, the certificate holder can request that the property be put up for sale by foreclosure.


Tax lien redemption periods

Most tax lien states offer redemption periods. That is a specific period during which anyone with a legitimate interest or claim on the property can pay the unpaid tax with additional fees and interest after the certificate is sold. Redemption periods vary by state or municipality and depend on whether the property is occupied or vacated. Vacant properties typically have much shorter payback periods, if any. Arizona, for example, offers a three-year refund period, which means certificate buyers have to wait three years before the foreclosure process begins, which can take a few extra months and a few thousand dollars in total. New Jersey withholding tax buyers must wait two years before applying withholding tax if the property is occupied. Still, if the property is unoccupied, there is no mandatory redemption period before starting the foreclosure process.


What a tax lien sale is like

Most states and municipalities conduct tax lien sales online, but some still conduct live auctions in county courts. Most require all bidders to register before the auction date and may charge a registration fee in advance. Investors can see which properties are for sale in the county auction calendar, which can be found online or by visiting the tax collection office. This allows investors to conduct their surveys of properties for sale, including:

  • Confirmation of the property's value

  • Confirming condition of the asset.

  • Look for other liens that may be older than the tax lien (such as senior tax lien or code violations)

Sales typically last 10 to 15 minutes per property, depending on the amount of unpaid taxes. If the property has equity, the auction can match the bid to the value of the property. The bidder who wins is the person who paid the most for the property in the auction and must make a county deposit (usually 10%) at the end of the sale. The remaining balance is due in a few days or even weeks. Most tax collectors only accept bank checks or wire transfers, and the short-term funding means that investors who want to purchase a tax lien must have the cash flow to complete the sale.


The advantages and risks of buying a property in the event of foreclosure

The most significant benefit of buying tax liens or pursuing a tax lien foreclosure is the ability to access discounted real estate. Most tax lien buyers bid on a tax lien with the intention or expectation of securing the title and knowing that the balance can be paid upfront. With this in mind, they set a maximum bid amount, which is essentially the minimum return they are willing to accept if the fee is paid in taxes and interest before the end of the repayment period. This means that the offer is generally based on the amount of unpaid tax against the property's value, which is heavily discounted from the property's actual value. While big discounts can be a big reward, there are several risks and drawbacks to this investing method, the first of which is the waiting period. Investors must wait a few years before starting the tax foreclosure execution to obtain ownership of the property. If the property is occupied, you can do little to ensure that the property is maintained or serviced as you expect or prefer. If the property was in excellent condition when the lien procedure started, it could be in very different conditions at the time of completion. A lot can happen in a few years. If the property is vacant, you can keep it in the best possible way. Still, you are also responsible for maintaining the property during the waiting period, which can be costly.

Using a tax lien to obtain ownership of a property means that you are also buying the property without fully knowing the internal conditions. Because you have no legal interest in the property before the sale, you do not have the right to access the property, which means you are competing for the right to tax without fully knowing the terms of the property. For this reason, it is always good to assume the worst and be prepared to make any improvements or renovations to the property after the title is obtained.

If previous tax liens have been sold, they are in a priority position over later tax liens sales, generally referred to as junior liens. Both can be profitable, but junior liens are often sold for a lower price because it is in a lower position. If the first tax lien holder requests foreclosure, this may hamper their ability to collect or obtain the title as intended. Tax liens and foreclosures can be tough investments, but they're worth it.

 

Tips for buying tax liens

Investors are advised to set a maximum bid for the property before the sale begins, which should be the minimum return you are willing to accept if the taxes are paid in full. There is always a chance that the certificate holder will void the property. Still, the fees are much more likely to be paid in full upfront, meaning you need to have the funds available and ready at the time of foreclosure but also happy with the return if not.

Although cash is necessary, investors can use other funding sources if necessary. The required redemption periods can give you more time to align the financing beyond the initial purchase, making this a very small initial investment for which you may or may not need additional funds. If you want to take out a tax lien and apply for a tax lien, familiarize yourself with your area's tax sales process, the legal process for foreclosing on a tax lien, and the associated costs. It's a good idea to register and go for bids and watch some sales to see the average return for your market.


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