What is a tax lien sale?

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.

In a tax lien state, the lien (consisting of delinquent taxes, accrued interest, and costs associated with the sale) is offered to prospective investors at public auction. Traditionally, auctions were held in person; however, Internet-based auctions (especially within large counties having numerous liens) have grown in popularity as this method allows for bidders from outside the area to participate.

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. (Florida and Arizona use this method)
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. (Colorado uses this method)
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 an Iowa county whose random selection method consisted of drawing numbered ping-pong balls from a fried chicken bucket).
4. Rotational Selection. Under this method, 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. However, bidder number one 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 virtually no control over which liens s/he will obtain in the bidding, except to take or refuse what is offered.
5. Bid Down the Ownership. Used in Iowa and few other states, 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 not redeemed, the investor would only receive 95% ownership of the property with the remaining 5% owned by the original owner. In practice, few investors will bid on liens for less than full right to the property or sale proceeds. 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 lien (plus interest and any other fees) may be repaid. 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, or else the certificate can be forfeit.

In some jurisdictions, the lienholder must agree to pay subsequent unpaid property taxes during the redemption period in order to protect his/her interest. If the lienholder does not pay such taxes, a subsequent lienholder would “buy out” the prior lienholder’s interest.

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.

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

Benefits of tax lien investing

• The maximum rate of return on a tax lien can be far higher than other investments. For example, Florida offers a maximum rate of 18% (1.5% per month), while Arizona offers a maximum rate of 16%. Iowa offers a guaranteed 2% per month (or 24% annual return).
  • However, as an incentive to encourage bidding, Florida law guarantees a 5% minimum return regardless of the rate bid (except if the bid is zero percent) or when the lien is redeemed. Thus, if a Florida certificate is purchased at auction on one day and redeemed on the next, the investor will earn 5% over the certificate price for one day’s holding, or a mind-boggling 1,825% return! [Loftis, the author mentioned above, in his book tells another story where he went to pay for a lien, only to find a redemption check waiting for him on the lien he bought; thus, he states that he obtained a return rate of infinity (to be mathematically correct, since it involved division by zero, the rate of return is actually not calculable).]
• In practice, the majority of tax liens are redeemed before the property is foreclosed; thus, the risk of loss is minimal.

Pitfalls of tax lien investing

• Payment is usually required at purchase or within a very short time afterward (often no more than 24-72 hours). Failure to pay the full amount results in all lien certificates purchased by the investor being cancelled, and may result in the investor losing his/her deposit and/or being barred from future sales.
• In many states further actions must be taken to protect the lien holder’s rights after purchase of a lien. Failure to comply exactly with these requirements may make the lien worthless.
• 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.) 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%