Tax deed properties: What they are and how to invest

If you find yourself experiencing sticker shock every time you look into buying real estate, you’re not alone. So, if you’re an aspiring real estate investor or house flipper, or you just want a more affordable way to become a homeowner, you might be wondering: Is there a way to buy property without breaking the bank?

Tax deed properties might be the answer you’re looking for. These are homes that have been foreclosed on by local governments due to their owners failing to pay property taxes. These properties are sold at a public auction, often for a fraction of their market value, to help the government recoup some of the debt owed. If you win the auction bid, you could snag a property for a lot less than what you might have paid on the open market.

But while buying a tax deed property can be a smart way to get an asset you can flip, rent out or enjoy, like any investment, these properties come with unique challenges. These include legal and logistical hurdles, in addition to financial risks. That’s why it’s vital to fully understand the specifics of tax deed sales and how they can help you turn a profit.

What is a tax deed?

A tax deed is a legal document that gives ownership of a property to a local government, or another entity, after the property has been foreclosed on due to unpaid property taxes. The local government holds a public auction, called a tax auction or tax foreclosure sale, in which anyone can bid on the property.

This is why failing to pay property taxes can be so devastating for a homeowner. Normally, homeowners pay property taxes annually, or monthly through their mortgage payment. However, if those payments lapse for too long, the property could get foreclosed on, losing the homeowner their property.

Essentially, unpaid property taxes lead to foreclosure, which leads to a public auction so the government can recoup some or all of the debt owed. The winner of the auction is then granted the deed to the property.

How tax deed sales work

The process for tax deed sales, and the steps leading up to and after them, varies by state. However, there are some general and common procedures that take place when a homeowner fails to pay their property taxes to the point of foreclosure.

For instance, it usually takes more than 1 year of missed property taxes to trigger major legal action. The homeowner is also given ample notice of the dangers of unpaid property taxes. Further, they are given time to pay the back taxes, usually with interest and penalties, before the property is foreclosed upon or auctioned off.

Here’s a list of common steps:

• The local government applies for the tax deed. This gives the government permission to sell the property at auction.
• The government notifies the property owner. This is done by mail, posting a notice on the property, and/or placing a notice in the newspaper.
• The property is offered at a public auction. There is a minimum bid amount that reflects the owed taxes, penalties, and costs.
• Auction attendees bid on the property. Auctions are either online or in-person, with the tax deed going to the highest bidder.
• The winning bidder pays for the property. Typically, there is a deadline of a few days to a few weeks after the auction.
• A redemption period ensues. Once the property is sold at auction and the tax deed is issued to the winning bidder, the former property owner often (depending on state rules) has a certain amount of time to redeem their property by paying off the taxes and penalties.
• The former property owner receives any excess money. The difference between bid and what was owed for back taxes goes back to the former owner.

Additional expenses after a tax deed sale

Winning a tax deed sale is a great feeling, but it can often be merely the beginning of a sometimes-long journey to profiting off your investment. The first challenge is making sure you have a clear title, because tax deed properties often come with other liens or legal defects. Here are two ways to clear a property’s title.

Whichever option you choose, you’ll likely need a real estate attorney, title specialist, or escrow company. While they add costs to your budget, it’s essential to get a clean title, especially if you plan to sell the property at any time.

Redemption periods during a tax deed sale

In many states the former owner of a property that has fallen victim to a tax deed auction is given a redemption period. This is a set amount of time they have to pay back taxes, interest, and penalties in order to get their property back. The amount of time can vary, depending on state laws. Here are a few examples:

• Georgia: Former property owners have 1 year from the time of the tax deed sale to reclaim their property by paying off their debt.
• Hawaii: Former property owners have 1 year to reclaim their property by paying off their debt.
• Tennessee: Unless it is expressly waived, former owners have 2 years to redeem their property.

If the former owner redeems their property after you’ve won and paid for the tax deed, you lose your right to the property. You typically do not lose any money, however. You get your money back and, depending on state laws, you also get interest and expenses paid. For this reason, it’s important to research the laws in the state you are considering pursuing a tax deed sale.

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

While tax liens and tax deeds might sound similar, there are some very important distinctions between the two.

A tax lien is a financial claim against a property made by the local government because property taxes have gone unpaid. A tax lien doesn’t transfer ownership of the property, but it stops the owner from selling or refinancing the property until the lien is cleared.

A tax deed, on the other hand, is a bit more serious. This is a transfer of ownership after foreclosure due to unpaid property taxes. The owner has lost their deed to the property, with the exception of a possible redemption period, depending on state law.

Like tax deeds, tax liens can be auctioned off. Buyers purchase certificates that represent debt owed. They earn interest on the debt, and if the property owner doesn’t pay back the lien, with interest, within a certain time, the tax lien holder can begin foreclosure proceedings to take the property.

In a tax deed auction, you are actually purchasing the property outright, subject, of course, to any redemption period or title defects.

Buying a tax lien

When you buy a tax lien, you’re not purchasing real estate. Instead, you’re buying the right to collect the back property taxes owed by the property’s owner, plus interest. Basically, you're giving the government the funds to cover the property taxes, so now the taxes are owed to you instead. Sounds good, right? Well, there are definitely some pros, but also some cons.

Pros

• Low initial cost: Tax liens are often only hundreds of dollars.
• Potentially high interest rate: States set the interest you can charge, but often it can be high – some states have 24% or even higher interest rates.
• Passive income: Since you don’t own the property, there is no maintenance or cost.

Cons:

• Foreclosure: If the owner doesn’t pay you, to secure the property and profit from it, you’ll need to initiate foreclosure proceedings, which can be lengthy and expensive.
• No asset: Unless and until you complete a successful foreclosure, tax liens are not a tangible asset.
• No guaranteed profits: If the owner doesn’t pay you or claims bankruptcy, other entities, like mortgage lenders, might be ahead of you in line to be repaid.

How to invest in a tax deed property

Buying a tax deed property can be a little more complicated – or at least unfamiliar – than buying property in a traditional real estate sale. Here are the general steps to follow:

• Locate county tax deed sales. Check county tax authority websites or reach out to local clerks to find upcoming sale lists.
• Attend and bid on a property. Get pre-registered, inspect the property if possible, set a firm maximum bid, and stay disciplined.
• Pay for the property. Have your funds ready. Most auctions require cashier’s checks or wire transfers within days of you placing a winning bid.
• Decide what to do after winning. Once you win a property, you’ll need to decide which is best for your goals. There are generally three options.

• Flip and sell: Renovate quickly, list with an agent.

• Pros: Relatively quick return on your investment.
• Cons: If you run into surprises, renovations may cost more than expected.

• Use as rental property: Hold it long-term for cash flow.

• Pros: Steady income, tax deductions, and potential appreciation.
• Cons: You are now a property manager with maintenance obligations.

• Sell as is: Ideal if you want to go for a quick profit.

• Pros: Fast sale with minimal work.
• Cons: If you misjudge what the property is worth, you could lose money.
  

Tax deed sale example

Imagine a scenario where someone attends a tax deed auction and places a winning bid of $30,000 on a property they later plan to sell. Here’s how the numbers might look in a simplified example:

This is a hypothetical example and doesn’t account for important expenses like real estate agent commissions, closing costs, repairs, maintenance, or holding costs. In reality, tax deed sales can involve risks such as title issues, competing liens, or challenges in reselling. 

The bottom line: Tax deed sales can quickly earn you profits

If you are interested in real estate investment but can’t afford the high cost of buying property on the open market, tax deed auctions are a viable option. Tax deed properties, which is real estate that has been foreclosed on due to lack of payment of property taxes, often are sold for well under market value at auction.

But these properties are also often neglected and have issues with liens and titles, so it’s important to thoroughly research auction rules, target markets, and potential risks. It’s also wise to budget for any unforeseen obstacles before bidding on a property.

If you’re ready to begin or continue your homebuying journey, Rocket Mortgage^® can help. Start your mortgage approval process online or give us a call at (833) 326-6018.