Jay Drexel with you here for an Awesome blog post!.
So, I created an awesome training program with the fine folks here at Awesomely called Tax Yields. In it, I talk about 4 levels of tax investing: Tax Lien Certificates, Tax Deeds, Hybrid States (Liens & Deeds), and Redeemable Tax Deeds.
And now, I’m inviting you to go a level deeper in understanding some key features of those levels. Lots to get it, so here we go…
Jumping into Tax Lien Investing
By definition, a lien is a claim against an item, which affects the ability to transfer ownership by another party, which utilizes that item as security for repayment of a loan, or other claim. Ad valorem taxes, otherwise known as property taxes, are county-assessed taxes on real property within the county boundaries.
Every piece of real estate is prone to property taxes: vacant land, raw land, and occupied land. The tax rate for each property is found by combining the property value and the county’s estimated budget for one year.
This is why the assessed value of the home is most often different from the fair market value.
The county uses property taxes to fund things like the fire department, police department, road signs, streets, development projects, schools, etc. That’s why this investment exists — to give the government their primary source of income. If property taxes were non-existent, then county governments would be bankrupt.
Tax Lien Scenario
A property owner fails to pay their property taxes. Many property owners pay property taxes along with their mortgage… but sometimes the property owner does not have a mortgage, or dies, so the property owner fails to pay property taxes by the due date.
Instead of raising taxes for people actually paying taxes, the county places a tax lien on the property.
After the tax lien is issued, it gives the county a way to collect debt differently: tax lien certificates. The county issues the tax lien certificate and announces the sale. People go to the website, find out about the sale, and show up to purchase the certificate.
Investors are not interested in the piece of paper, but in what the certificate represents — guaranteed interest on investment!
The collection of property taxes is done by municipalities and governed by the state. Each state is free to set their own rules for how they will sell and reward the buyer for each tax lien certificate, with few federal laws that bind the states.
That’s why the reference material on the website is crucial — each state differs and requires specific understanding. The states are remarkably similar in how they reward and function, with small differences…
For example: Different states will give higher percentage rates to the investor, or longer redemption periods for the property owner.
The county holds the tax sale and investors show up to buy the certificate. Investors want the interest that is promised by the government for that certificate. The auctioneer presents the certificate to the investors and the ones interested bid on the certificate.
Impt. Note: Let me be clear that the investor did not pay taxes for the property owner but purchased a certificate in the same amount the property owner owes to the county. The investor does not own the property, but the certificate. The investor may have the right to take ownership after the redemption period ends if the property owner fails to pay their taxes.
Now, let’s also say this investment was made in Florida, where the interest rate is 18% and the redemption period is 2 years. When the investor buys the certificate, the interest immediately builds up.
Unlike stocks, or any other investment, you don’t have to watch and worry about if the values are rising or dropping and if you’re making or losing money every day. Tax liens let you know that you are making money and you can calculate the money you are making daily.
Back to our scenario: To remove the tax lien from the property, the property owner has to pay property taxes to the county, not the investor. The property owner is unaware the investor exists. The property owner goes about their normal business and pays the property taxes owed but is also required to pay a late penalty.
The county then writes a check to the investor for the amount of the taxes, plus the interest paid as a penalty for the owner. The property owner had to pay the same 18% the investor earned, and the county passes that money straight to the investor.
What if the property owner never pays the proper tax amount?
Well, the tax lien certificate the investor bought gives them the right to take ownership of the property through foreclosure. This means that with tax liens, you either get your investment plus a high interest rate such as 18%, or you get the property.
This is a win/win/win situation. The county gets their operating money, the property owner gets a redemption period to pay their taxes, and the investor gets a great return.
Tax Deeds
OK, the tax deed system is extremely similar to the tax lien system, but the investments are offered at another point in the county’s timeline.
Quick Review: The county depends on property taxes to support things like the fire department, the police department, roads, schools, etc. When property owners fail to pay property taxes, the county is left in a difficult position. They have to try and replace their primary source of income. Instead of raising taxes for those who pay — they made a great system that allows investors to loan money to the county in exchange for assets. The county issues a tax lien on the property to keep the property owner from selling their property and creates a tax lien certificate with a state-mandated interest rate to sell to investors. They give the delinquent property owner a certain amount of time, usually 1 to 3 years, to pay back property taxes to the county.
Remember, the property owner does not write a check out to the investor, but to the county. The county issues the initial notice of default and announces the sale of the tax lien certificate. The property owner is notified that there will be a penalty for paying property taxes late.
When the property owner pays property taxes and their penalty to the county, the county writes a check to the investor for the original investment plus the interest built up to that point. If the property owner fails to pay during the redemption period, the investor has the opportunity to take ownership of the property through foreclosure.
Tax Deed Process
The county does not sell a certificate with an interest rate to tax deeds… but sells the deed to an already foreclosed property.
When the property owner is delinquent, the county issues a delinquency notice and issues a tax lien to the property, so the property cannot be sold. The county gives the property owner a set time to pay off their property taxes. The redemption period starts when taxes are due…
If taxes are due April 1, and the redemption period is 2 years long, the property owner would have until April 1 two years later due to the increasing penalty. If the property owner pays the taxes and penalty, the county takes the money and moves on.
If the property owner fails to pay during the redemption period, the county begins the foreclosure process. The county takes control of the property through foreclosure and announces its sale.
Then, the county makes a public notice of the auction: in the newspaper, on the county office bulletin board, on their website. Educated investors show up and start bidding on tax deep properties.
Bidding begins at the amount of the delinquent property taxes and goes up according to the competition. Depending on the number of investors interested in that particular property, the property can go for extremely low prices. The winner walks away with a tax deed to the property and a big smile.
Differences
The primary differences between tax liens and tax deeds are that tax liens are usually long-term investments and tax deeds are short-term investments.
You can get into tax liens at lower prices than tax deeds — for tax liens you get a certificate with the promise of an interest rate, and with tax deeds you get the property.
Tax deeds are extremely exciting because it’s possible to get amazing deals since the bidding starts so low.
Finally…
Redemption Deeds
Redemption deeds are a mixture of tax liens and deeds.
How?
They’re tax deeds with a redemption period.
You’re buying real property, but the property owner gets one more chance to redeem, or buy the property back. The good news is that the property owner has an attached penalty. Interest rates tend to be overly high for redemption deeds.
Another Review: The property owner is responsible for some amount of money to pay the county in property taxes. Property taxes are the primary source of income to support a county. When the property owner fails to pay the taxes, the county is left with a need for money. The county immediately offers the redemption deed for sale to investors, instead of issuing tax lien certificates. They announce the sale, and investors come to bid on redemption deed properties. The winner does not walk away with a tax lien certificate with an interest rate or a deed to the property with full control. The winner walks away with a redemption deed that has a remarkably high interest rate attached with the promise of property ownership if the property owner fails to pay property taxes during the redemption period.
Interest Rates
The advantage of a redemption deed is the promise of higher interest rates like 24% and 25% and taking ownership at the end of the redemption period. It’s also much simpler to take ownership at the end of the redemption period.
Let’s look at an example: Texas.
Texas offers 2 redemption periods depending on the property type. For homestead properties, the redemption period is 2 years… in this case, the longer the better. For the first 6 months of the redemption, there is a 25% penalty. That means that if the property owner redeems within the first week, the investor will make 25%. After the first 6 months, you make another 25% penalty, making the total for the first year 50%.
If the property owner fails to redeem after the first year, another 25% penalty is added, making the total potential return 75%.
If the property owner never redeems, the property is all yours.
If the property is non-homestead, the redemption period is only 6 months. Non-improved properties are improved lots, vacant land, raw land, etc. On that investment you will make a 25% penalty or take immediate ownership after 6 months.
It’s not hard to imagine why this strategy is getting popular, especially in Texas.
Know this: When you speak with the county, they might not know what you’re talking about if you say you’re looking for redemption deeds. This is just a descriptive term we’ve come up with. They may refer to them as tax deeds or tax sales.
Another note: Sometimes the country doesn’t handle the auction but will outsource operations, announcements, and management to another company… sometimes a law firm.
OK…
Yeah, that was a lot… but I think I’ve shared it in a way that’s digestible and understandable. When people hear tax lien, tax yield, certificate — they often freak out. No need. Just review what I’ve broken down and it’ll make sense.
And, now that we’ve gone a level deeper in understanding the tax yields ecosystem and asymmetric opportunity that exists for savvy investors to tap into…
I hope to see you in the Tax Yields training soon. 😊