Tax Deed vs. Tax Lien [What are the Differences?]

Published on June 30, 2023
Tax Deed vs. Tax Lien [What are the Differences?]

Tax Deed vs. Tax Lien [What are the Differences?]

When it comes to investing in real estate, two intriguing yet lesser-known strategies are buying tax deeds and tax liens. These terms refer to techniques that involve purchasing either distressed properties or the tax debt associated with them.

Remember that property tax is any tax paid on a piece of property and, therefore, should be settled by the homeowner. Failure in paying can lead to the sales formerly mentioned.

While both tax deed and tax certificates can offer lucrative opportunities for a real estate investor, it's crucial to understand their differences and unique implications. Thus, in this blog, we will delve into the exact difference between the two, examining how they function, their potential benefits, and the risks associated with each type of investment.

What's the Difference Between a Tax Deed Sale and a Tax Lien Certificate?

What's the Difference Between a Tax Deed Sale and a Tax Lien Certificate?

Tax deed sales and tax lien certificates are both tools used by municipalities to collect delinquent property taxes, but they function quite differently. In general, these two involve the sale of the property when the owner fails to pay their outstanding tax dues.

Property taxes are used to fund various municipal programs, so when a property owner fails to pay, the lien is transferred to the highest bidder and it will go through a series of steps which transfers the ownership to the purchaser.

Important note: In both tax lien certificates and tax deed sales, the original owner has a certain period in which they can repay the delinquent taxes (plus penalties, fees, and interest) to retain their property. Most states have a redemption period, but the steps vary with local and municipal rules.

Tax Deed Sale

In states that use the tax deed system, if a property owner fails to pay their property taxes, the county authority may sell the property's actual ownership rights to the property (in the form of a tax deed) to collect the owed taxes. Of course, the whole processes include notifying the property owner.

The buyer of the tax deed then becomes the new owner of the property. This can potentially be a way to acquire property significantly below market value. However, it's important to note that local tax deed sales often involve an auction process, where the property goes to the highest bidder.

Example of a Tax Deed Sale

Let's say there's a property in Orange County, Florida, where the owner has failed to pay their property tax payments for the past three years. The county's taxing authority decides to auction the property to recover the unpaid taxes. 

At the public auction, several investors bid on the property, which has a market value of $200,000. The highest bid is $70,000. The winning bidder pays this amount to the county within a specified period, covering the delinquent taxes, and in return, they receive the deed to the property, effectively becoming its new owner. Typically, the investor should pay the entire amount owed within 48 to 72 hours or else, the sale is canceled and the former property owner has an opportunity to recover the outstanding taxes and pay them.

They now have the potential to either rent or sell the property, possibly realizing a significant profit. However, it's crucial to remember that they bought the property "as is," meaning they assume all responsibility for any necessary repairs or issues that might arise.

Tax Lien Certificate

In areas that use the tax lien system, when property taxes are not paid, the county places a lien on the property. The county then sells that lien in the form of a tax lien certificate at an auction. 

The investor who purchases the certificate (refers to a legal document issued by the county) pays the delinquent taxes to the county and, in return, receives the right to collect the tax amount plus interest from the property owner. 

If the owner does not pay the taxes and interest within a certain period (the redemption period), the holder of the tax lien certificate has the right to foreclose on the property.

Example of a Tax Lien Sale

Imagine a homeowner in Baltimore, Maryland, who has not paid property taxes for several years. Maryland operates under a tax lien system, so the city decides to sell a tax lien certificate on the property to recover the unpaid taxes. 

At the tax lien auction, several investors show interest in the certificate, which represents $10,000 in unpaid taxes. The highest bidder wins at the auction at a 12% interest rate, which is what the homeowner will have to pay back on top of the owed taxes. 

The investor pays the $10,000 to the city, and in return, receives the tax lien certificate. Now, the homeowner owes the investor the original $10,000 plus 12% interest. 

Since the property owner must pay this within the redemption period specified by the state or municipal programs (in Maryland, it's usually six months), the investor receives their investment back plus the 12% interest. This means the owner still has an opportunity to own their piece of property. That is, if they keep their taxes up to date.

If the homeowner cannot pay within the redemption period, the investor has the right to initiate foreclosure proceedings to take ownership of the property. In this case, the homeowner won't get their property back.

How Can Real Estate Investors Leverage Tax Liens and Tax Deeds

How Can Real Estate Investors Leverage Tax Liens and Tax Deeds?

Although the process can be quite complicated, many real estate investors still choose to invest in tax liens and tax deeds. If you are intrigued as to why, check out the following benefits of tax liens and tax deeds.

High Return on Investment

Tax liens, in particular, can offer high rates of return because of the interest rates charged on the underlying property tax debt based on local and municipal laws. These rates are set by law and can be significantly higher than those of other investments. This is especially true when the minimum bid of the amount is relatively cheap.

Diversification

Adding tax liens or tax deeds to an investment portfolio can help diversify an investor's holdings and reduce risk. Applying for the tax deed sale is also easy.

Property Acquisition Below Market Value

In the case of tax deed sales, investors often have the opportunity to acquire properties at prices below their market value, since the bidding often starts at the amount of back taxes owed and can be less competitive than traditional real estate markets.

Secured Investment

Unlike many other types of investments, tax liens and tax deeds are secured by real property. If the property owner fails to pay their tax debt, the investor has the right to foreclose on a tax lien or takes ownership of the property in a tax deed sale, providing a level of security.

Low Entry Option

The cost to invest in tax liens or tax deeds can be lower than other real estate investment options, making it more accessible to a wider range of investors.

Risks of Investing in Tax Liens and Tax Deeds?

Investing in tax liens and tax deeds, while potentially profitable, carries inherent risks. You should be aware of all of these risks to ensure that your investment would not cause you a headache in the end.

There May Be Other Liens Associated with the Property

Real estate can have multiple liens against it, not just tax liens. These might include mortgage liens, mechanic's liens, or judgment liens. Some of these liens may take precedence over tax liens, meaning they must be paid off before the tax lien in a series of legal steps. 

Therefore, even if you foreclose on a tax lien, you might end up having to pay off other liens, which could significantly cut into your returns. This is why it's crucial to perform a title search before bidding on a tax lien or tax deed.

There May Be Municipal Debt Not Yet Recorded as a Lien

Sometimes a property might have debts, such as water or sewer bills, that the municipality has not yet recorded as a lien even when a sale takes place through an auction. 

If you acquire the property, either through foreclosure of a tax lien or a tax deed sale, you might end up being responsible for these debts. It's important to thoroughly research any potential additional obligations before making an investment.

The Owner Files for Bankruptcy

If a property owner who couldn't pay back their tax debt files for bankruptcy, it can significantly complicate the tax lien or tax deed process. Bankruptcy proceedings can delay or even stop the foreclosure process on a tax lien. This is even though the tax deed legally transfers ownership to the highest bidder or transfers ownership to the purchaser.

In some cases, a bankruptcy court may even wipe out a tax lien if it determines that there is not enough equity in the property to cover the unpaid property taxes. 

In the case of a tax deed, if the owner declares bankruptcy after the sale but before the redemption period ends and they have a legal document granting ownership of a property, the court might allow them to keep the property.

Tips When Investing in a Tax Lien and a Tax Deed

Tips When Investing in a Tax Lien and a Tax Deed

Investing in tax liens and tax deeds can be a profitable venture, but it requires knowledge, preparation, and due diligence. To help you make your first deal, we’ve rounded up some of the best tips from expert real estate investors in this niche.

  • Do Your Homework:Before you consider investing, take time to understand the rules and regulations as well as the differences between tax lien certificates or tax deeds in the area where the property is located. Laws can vary significantly by state or county.
  • Conduct a Thorough Title Search: Before bidding on a tax lien or tax deed, conduct a thorough title search since the taxing authority may sell without doing this. This can uncover other liens or claims on the property, which may need to be paid if you eventually acquire the property.
  • Assess the Property: If possible, assess the property in person. This can be tricky with tax lien or tax deed properties as you often cannot access the interior, but at least drive by to evaluate the exterior and neighborhood. This will give you a better idea of the property's potential value and the extent of repairs or renovations needed. This will also tell you the reason why the owner may sell the property's deed readily.
  • Set a Budget: It can be easy to get caught up in the auction process and pay more than intended. Set a maximum bid amount before the auction, based on your evaluation of the property and its potential return on investment.
  • Understand the Redemption Period:Be clear about the redemption period applicable in your jurisdiction. This is the time period during which the original owner pays the outstanding tax amount (with interest) or tax obligations and reclaim their property.
  • Be Patient:Investing in tax liens or tax deeds is often a long-term strategy, particularly with tax liens where you may need to wait out the redemption period. You'll need patience and capital that you can tie up for a while.
  • Consult Professionals:Consider consulting with a real estate attorney or investment professional who has experience with tax liens and tax deeds. They can guide you through the process and help you avoid potential pitfalls. They can guide you about the costs associated with selling the property, understanding back taxes owed plus interest, how taxes are assessed by the municipal government, potential risks of an upcoming tax lien when they aren't paid by the owners, etc.

Final Thoughts: Tax Deed vs. Tax Lien [What are the Differences?]

Both tax deeds and tax liens present unique opportunities for real estate investors seeking to diversify their portfolios or discover unconventional routes to property acquisition and investment. 

While tax deeds can potentially enable investors to acquire properties at prices below their market value, tax liens offer the potential for high returns or, in some cases, eventual ownership of the property. 

If you find the differences between a tax lien and a tax deed complicated, you might want to try other types of leads for real estate investing. To help you find the most motivated sellers, check us out at Property Leads!

We sell motivated leads exclusively, so you are guaranteed a higher chance of closing a deal. Make sure to fill out the form below to get your first leads from us!

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