Tax Deed Sales
April 29, 2008
A tax deed sale is the forced sale, conducted by a governmental agency, of real estate for nonpayment of taxes. It is one of two methodologies used by governmental agencies to collect delinquent taxes owed on real estate, the other being the tax lien sale.
[edit] Tax Deed Sale Process
Real estate taxes are considered delinquent if not paid within a specified period of time. If the taxes are not paid, after legal requirements are met (such as giving proper notice to the property owner as well as others holding an interest in the property, or by filing required action in the courts), the property is offered for sale at public auction.
The minimum bid is generally the amount of back taxes owed plus interest, as well as costs associated with selling the property. In the event the property is not purchased, title reverts to the government. The government may then attempt to sell the property at a public auction and/or offer it for sale in a private transaction.
In most cases, the jurisdiction will only provide a quitclaim deed at the sale, which is usually insufficient for title insurance. Therefore, a “quiet title” action must be filed in court to obtain an insurable title.
Some jurisdictions allow a “redemption period”, whereby the former owner has a specified amount of time to reclaim the property by repaying the amount bid at auction plus a penalty. For example, Texas allows a 6-month period in most cases, with a flat 25% penalty to be added to the amount paid at sale (for agricultural and homestead property the period is 2 years and if redeemed in the second year the penalty is 50%), while Tennessee allows a full year, with a 10% penalty. As such, purchasers of properties at tax deed sales are cautioned not to make major improvements on the property until after the redemption period has expired.
Other jurisdictions do not allow a redemption period (for example, Florida). However, the prior owner can still attempt to challenge the validity of the tax sale, for example by claiming that proper notice was not given.
Tax Lien Article 1
April 29, 2008
In a tax lien state, the lien is offered to prospective investors at public auction. Most auctions are held in person; however, Internet-based auctions (especially within large counties having numerous liens) are becoming more common.
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:
- 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)
- 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)
- 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).
- 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.
- Bid Down the Ownership. Used only in Iowa, 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 redeemed, the investor would only receive 95% of the proceeds. 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.
[edit] Redemption process
The investor must wait a specified period of time (referred to as the “redemption period”), during which time the property owner (or someone with an interest in the property) may repay the lien with interest. 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 less interest rate than had the lien been valid.
[edit] Hazards of tax lien sales
The rates of return can be highly attractive. For example, Florida (a popular tax lien state due to its growth and investor-friendly rules) is a “bid down the interest” state with a maximum rate of 18% (1.5% per month). However, 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 certificate is purchased one day at 0.25% (the lowest possible rate greater than zero percent) and redeemed the next day, 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 actually obtained a return rate of infinity, or, mathematically speaking, it has no meaning since it involved division by zero) Iowa, another tax lien state, offers a guaranteed 2% return per month (or 24% return per year). And, in practice, most liens are redeemed before the property is foreclosed.
[edit] 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 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% – though it guarantees a minimum 5% return – while Arizona allows the bid to be as low as 1%.) Similarly, in “premium” states, valuable properties are bid up above the means of an average investor.
- Unlike a certificate of deposit, tax liens are illiquid. They cannot be “cashed in” (resold to the taxing authority), but must be held until either they are repaid or the holder takes action to foreclose. (It is possible, however, to assign one’s interest in a tax lien to another party.)
Tax Lien Fund FAQs
April 6, 2008
FAQ’s
What is a tax lien certificate? A tax lien certificate is issued by a county government when a tax payer is delinquent in paying his/her yearly property tax. The county records a first priority tax lien on title and sells the lien to an investor. Major Banks, insurance companies and Wall Street financial institutions have been investing billions in tax liens for over 100 years.
What is a first priority lien? A tax lien has priority over all other liens secured by the property including the first mortgage. Some exceptions apply to federal and state income tax liens.
How long is the Fund’s capital invested in liens? Most of the 25 lien states allow the property owner, their heirs, the lenders and the mechanic lien holders a redemption period of 6 months to 4 years to redeem (repay) the lien (back taxes) and the interest and/or penalty. During this time, the county assesses a high interest rate and or penalty and county fees. Historically most liens are redeemed (repaid) within one year, but may take up to four years. If the lien is not redeemed, foreclosure proceedings may take anywhere from 3 months to two years to finalize.
How long will I be invested in this managed lien fund? The fund will begin liquidating assets in the 5th year. Most of the remaining liens will be redeemed and all of the properties acquired through foreclosure will be sold.
Where is the risk? Risk occurs from purchasing bad liens on poor properties. Every lien has the potential to not be redeemed. That is where Lien Baron’s experience and expertise helps minimize risk for the investor. Fund management must decide 1) which liens to purchase and 2) which unredeemed liens to foreclose on. Due diligence and use of industry specific custom software help mitigate the risk of purchasing bad liens on poor properties. The fund will retain outside legal assistance in the processing of liens and foreclosure to ensure minimal risk to investments.
What kind of return can I expect? Each state and county sets a rate of interest that must be paid by the party who wants to redeem (repay) the lien. Interest rates range from 8% to 50% per year depending on the state/county. When the Fund is able to foreclose on a property, returns can be from 100% to over 1,000% with the sale of the property. See the “Sample Property” page for an example of a portfolio of properties purchased at one tax sale by the fund manager. The Funds target return is 25% to 30% per year.
How often will I receive a check from the Fund? Annually. The fund will pay out net redemption proceeds received and accrued interest earned every year. Investors will receive a financial report that includes a list of all liens purchased and redeemed each quarter, listed by county.
How is the fund structured? The fund is structured as a Delaware LLC. Investors will purchase an interest, or membership in the LLC. The managing member is Lien Baron, LLC. As an LLC, investors are not expected to assume any additional risk of loss or liability beyond their original capital investment.
What is the minimum amount that I must invest in the Fund? The Fund will offer units at $25,000 per unit, with a one unit minimum. The maximum invested capital will be capped at $5,000,000.
Who can invest? The fund will be open only to accredited investors who meet the eligibility requirements set forth by the SEC, and a certain number of non-accredited investors.
How does the Management get paid? Management charges a 2.5% fee for assets under management. This pays for overhead expenses and salaries. Management also receives 20% of the profits of the fund, so the manager only makes money when the fund makes money. Investors will receive 80% of the profits of the fund.
What kind of income taxes will I have to pay? The fund will generate interest and penalty income, both received and accrued from liens along with short-term and long-term capital gains from acquired property sales. The fund will issue a Schedule K-1 at the end of each calendar year reflecting each investor’s allocable share of taxable income. Investors may be able to invest in the fund through a tax free or tax deferred IRA. Please contact your tax advisor for advice on how investing in the Fund will affect your personal tax situation.
How experienced is the management team? Stephen Jonas has purchased hundreds of thousands of dollars worth of tax liens. Mr. Jonas brings years of real estate and investment banking experience to the Fund. Previously, Mr. Jonas was senior investment analyst for a private commercial real estate investment bank and provided financial and investment analysis on over $1 Billion in commercial real estate deals. Prior to working for the investment bank, Mr. Jonas was founder and president of a private residential real estate company which purchased and renovated single and multi-family houses. Over the last 5 years, Mr. Jonas has been directly involved in over $50 Million in commercial and residential real estate transactions.