First of all, let’s discuss tax liens and tax deeds. As we all know, governments (local, county and state) use taxation as a way to raise capital to fund their operations. One of the major taxing methods is the real estate property tax. Basically, the government charges property owners a yearly fee that is determined by the local tax rates and the assessed value of the property. If the property owner doesn’t pay the property taxes by the due date each year, then the government places a lien against the property for the amount of the defaulted payment. The tax lien clouds the title of the property so that it cannot be sold without the government getting paid the taxes due on the property.

It’s important to note that tax liens take precedence over all other liens, and the government can and will seize and sell property for unpaid taxes. Generally, liens on a property are given priority based on the date the lien is recorded. The first lien recorded is in the first position, the second lien recorded is in second position, and so on, but not so with tax liens. Tax liens, no matter when recorded, can jump to the front of the line and claim first position, ahead of mortgages and other liens. This is one reason banks like to collect property taxes with the monthly mortgage payments and place them into an escrow account. The bank then pays the property taxes when due each year, eliminating the possibility of a tax foreclosure by the government.

In each of the states, after a tax lien is placed on a property, the owner is given additional time to pay the back taxes (from six months up to four years, depending on the state). If the back taxes are not brought current by the deadline, the taxing authority (usually the county) will hold a tax sale and auction off either a tax lien certificate or a tax deed. Twenty-eight states use tax lien certificates and the rest use tax deeds. However, a few states use a combination of tax lien certificates and tax deeds.

What is the difference between a tax lien certificate and a tax deed?

Tax Deeds - In states that provide tax deeds to the bidders at a tax auction, the deeds to the property are actually issued at (or right after) the tax sale. The deeds either wholly or conditionally transfer title to the subject property from the tax-delinquent owner to the successful bidder. The type of deed that is issued is different for each state, but in most states it is a non-warranty deed. This means that there is no warranty as to the condition of the property, no warranty of the condition of the property title, and no guarantee that the property even exists.

So, just because you get the deed to the property doesn’t mean you can count on moving in or selling the property the day after you purchase it at the auction. Most of the time you will have to go through a quiet title action to clear the title before you can sell. And several states give the original owner a redemption period in which they can still reclaim the property, even after you have been given the deed. The rules which govern how the redemption takes place and how much the original owner would have to pay to reclaim the property vary from state to state and even county to county. That is one reason it is critical that you understand all the rules and regulations governing tax liens and deeds and the state’s statute on redemption in a specific state and county before you bid at the auction!

Tax Lien Certificates - In the states that use tax lien certificates, the title to the property is not given to the successful bidder. Instead, they are given a tax lien certificate that creates a first-priority lien on the property with the right of foreclosure – again, subject to the state’s statutory right of redemption. The buyer of the certificate pays all the back taxes that are due and other expenses. They must then wait through the redemption period (six months to four years). In order for the delinquent owner to redeem the property during the redemption period, they must pay the certificate holder the full amount that was paid for the tax certificate, along with interest, any penalty fees, and sometimes expenses. The interest rate on the tax lien certificates is set by each individual taxing authority and ranges from six percent to 24 percent. With penalty fees in some states, the overall interest on tax lien certificates can reach upwards of 50 percent. That is not a bad return on a relatively safe investment, considering what rates banks are paying on savings these days.

Most people who purchase tax lien certificates do so for the higher rate of return they can make on their investment and not to gain title to the property. Statistically, more than 95 percent of tax lien certificates get redeemed. Very few people will let their home ownership slip away for just the back taxes. However, it does happen. So a very important rule is to never buy a tax lien certificate for a property that you would not want to own. You only want to bid on properties that are saleable and/or rentable because, if the certificate does not get redeemed, your only remedy to reclaim your investment is to foreclose on the property. The property is the security for your investment. But you need to go through the foreclosure process in most states to get the deed to the property. Again, it is critical to know the state’s rules and regulations that govern how the foreclosure is handled.

If your goal is to get a good interest rate and great return, you should probably bid on nice homes in nice neighborhoods, preferably owner-occupied homes. Owners of these properties will most likely redeem the tax lien certificates. But if you want to gain title to the property, then you should concentrate on distressed homes in distressed neighborhoods. There is a better chance of actually obtaining title to these properties in the long run, especially if they are really rundown, vacant, abandoned, neglected and/or owned by an out-of-state owner.

Which states offer tax lien certificates?

The states which offer tax lien certificates and the interest rates required for certificate redemption are shown in the following list. However, interest rates could be different if there have been any recent changes in the state statutes.

State Interest Rate

Alabama 6%
Arizona 16%
Colorado 10%
Florida 18%
Illinois 18%
Indiana 10% to 15%
Iowa 24%
Kentucky 12%
Louisiana 17%
Maryland 12% to 24%
Massachusetts 14% to 16%
Mississippi 17%
Missouri 10%
Montana 10%
Nebraska 14%
New Hampshire 18%
New Jersey 20% to 24%
New York 10%
North Dakota 9% to 12%
Oklahoma 8%
Rhode Island 6% to 18%
South Carolina 8%
South Dakota 12%
West Virginia 12%
District of Columbia 18%

Which states offer tax deeds?

The following states sell tax deeds: Alaska, Arkansas, California, Idaho, Kansas, Maine, Minnesota, Nevada, New Mexico, North Carolina, Ohio, Oregon Pennsylvania, Texas, Utah, Washington, and Wisconsin.

Some states have laws that allow for both tax deed and tax lien sales and it may vary from county to county within the state. Connecticut, Florida, Massachusetts, Michigan, Nebraska, New Hampshire, New York, North Dakota, and Vermont are the states that can sell both tax lien certificates and tax deeds. You will need to check with each specific county in each of these states in order to determine what is being sold at their tax sales.

Which states have redeemable tax deeds?

Some states sell redeemable tax deeds. The successful bidders in these states are issued a deed to the property, but there is a period of time (the redemption period) during which the delinquent taxpayer can reclaim (buy back) the property by paying the amount that was bid plus a prescribed penalty. After the redemption period is over, if the owner hasn’t reclaimed the property, the winning bidder can obtain clear title to the property, usually through a quiet title action (a court action to establish ownership of the property). States that sell redeemable tax deeds are Connecticut, Delaware, Georgia, Hawaii, Rhode Island, Tennessee, Texas, and Vermont.

What are the various bidding methods used by different states?

Make sure you understand the bidding process and how it works in your particular county. There are several different techniques that are used to determine the winning bidder for states auctioning tax lien certificates:

• Bidding the interest rate down. In some states, like Florida and Arizona, the bidding starts at the maximum interest rate set by the statute and each bidder bids a lower interest rate. For example, in Arizona (as of this writing) the maximum allowable interest rate for tax-lien certificates is 16 percent. Potential certificate buyer’s bid 15 ½, 15, 14 ½ percent, etc. until the lowest interest rate someone is willing to accept is reached. That person purchases the certificate at the ending bid rate. If the certificate gets redeemed, the delinquent taxpayer still must pay the full statuary rate, and the county keeps the spread.
• In some states, the auctioneer is auctioning a percentage of interest in the property in the event the certificate is not redeemed and the certificate owner has to foreclose on the property. In other words, the bidders start bidding 99 percent, 98 percent, 97 percent, etc. until the lowest percentage of interest someone is willing to accept is reached. In the event of a foreclosure, the certificate owner could own anywhere from 99 percent down to one percent of the property, compared to the property owner’s one percent to 99 percent. Under this system, the bidders are looking to get the statutory rate from a redeemed certificate and not planning on a foreclosure. There is some risk involved, however, as there is with any investment, if the certificate is not redeemed. You just need to know the rules and the level of risk you want to take before getting involved in tax lien investing.
• Other states, like Colorado, use a premium bid system. In states using this system, the law allows the face amount of the tax lien certificate to be bid up. In other words, there is a statutory rate of interest that is paid on the face amount of the certificate, but the bidder may pay more than the face amount for that certificate in order to win the bid. In some states, the successful bidder gets this premium back if the certificate is redeemed and in other states, the successful buyer does not get the premium back and the county keeps the premium amount. Know the rules before you bid.

For most states that are selling tax deeds, the auction is like a typical auction where the deed will go to the highest bidder (highest bid over the taxes due). Some states, however, also use sealed-bid type auctions, where there is a deadline to submit the bid and all bids are then opened and the highest bid gets the deed.

In the next article on tax liens and tax deeds, we will discuss several additional items:

• Where is the best place for you to invest in tax liens?
• Should you invest in tax lien certificates or tax deeds?
• Advantages of buying “after” the tax auction.
• The importance of doing due diligence on tax lien properties.
• Buying tax-liens online.
• How to take a tax lien vacation.
• Where to find information on the thousands of tax sales being held in counties all across the country.

As you can see, to be successful in investing in tax lien certificates or tax deeds, you need to know what you are doing. Knowing the rules of the game is one of the most important factors to successful investing in tax liens and/or tax deeds. It is a great game, with lots of money to be made, but you must do your homework before you play or you could get hurt.