About Tax Lien Sales
A tax lien is imposed against real estate when the owner fails to pay taxes. In most cases, tax liens are the result of delinquent property taxes. In a tax lien sale (not to be confused with a tax deed sale), the debt, not the property, is publicly auctioned by the government in order to generate income that payment of the delinquent tax would otherwise have provided. At a tax lien sale, the purchaser pays the delinquent tax debt and in exchange is granted a first lien on the property (ahead of the mortgage), which may be foreclosed under certain conditions.
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Value
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The amount of the tax lien is the amount of the underlying tax debt plus interest and costs of the sale. In some states, competing bidders offer to pay a premium above this amount in order to obtain the lien. The government also offers the lien holder a guaranteed rate of return as long as the lien is held.
Bidding Methods
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There are five bidding methods used by state governments to select among competing bidders for tax liens: random selection, premium, rotation, ownership stake bid-down and interest rate bid-down. Random selection is just how it sounds: A bid is just picked at random. The premium method offers the lien to whichever bidder offers to pay the most for the tax lien. The rotational method places bidders in a queue and gives the first bidder a right of first refusal, after which point the following bidders are offered the lien according to their place in line. The ownership stake bid-down method awards the lien to the bidder willing to accept the tax lien encumbering the lowest percentage of the property. Finally, the interest rate bid-down method awards the tax lien to the bidder willing to accept the lowest rate of return from the government. The particular method used varies from state to state.
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Redemption
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Under the laws of every state, the delinquent property owner has a statutory time period (up to one year in some states) in which to "redeem" the property: to purchase the tax lien from the winning bidder at a nonnegotiable price, and extinguish the lien. The lien holder cannot foreclose before this statutory redemption expires. Once this period comes to a close, however, the lien holder may foreclose and either take title to the property or hold a tax deed sale of the property in which the lien holder has the right of first bid.
Benefits
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Tax lien investing can be profitable in two ways. States generally offer very high rates of return to tax lien holders: 18% - 50%. And if the property in not redeemed (a relatively unusual occurrence), the tax lien holder may acquire the property at a price well below market value.
Risks
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State regulatory requirements regarding the purchase and holding of tax liens can be complex and confusing, and if they are not strictly complied with the investor may lose his/her deposit on the tax lien sale, or may end up obtaining a worthless lien. If the investor acquires title to the property, a quitclaim deed is issued, which does not provide insurable title (a quitclaim deed transfers whatever interest the seller has in the property, and does not even guarantee that the seller owns the property at the time it is sold). In order to obtain insurable title, a "quiet title" action must be filed with the state courts to obtain legal confirmation that the investor owns the property outright, free of any competing claims. Finally, the investor may lose part or all of the investment if the owner declares bankruptcy during the redemption period.
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