Tax Lien Foreclosure Explained

Key Takeaways:

  • Tax foreclosures describe when an individual who purchased a tax lien certificate initiates a judicial foreclosure proceeding against the property so that a foreclosure auction is held to generate money to satisfy the unpaid tax lien. 
  • A tax lien is a legal document sent by the IRS or a government entity with the purpose of securing a claim to an asset in a situation where the owner’s tax bill continues to go unpaid.
  • The two types of tax sales that may be pursued by a government municipality as a result of unpaid property taxes include a tax lien sale, which involves selling the tax lien certificate on the property to someone who can pursue other collection attempts, and a tax deed sale, which involves selling the property.
  • Some of the advantages of investing in tax lien certificates are that there is usually a high rate of return and the minimum investment requirement can be low. Some of the drawbacks of investing in tax lien certificates are that the full payment must be completely paid in a short period, the asset is illiquid, and it requires thorough research to determine if the property is a valuable investment.

Table of Contents

What Is Tax Foreclosure?

Tax foreclosure, also known as tax lien foreclosure, describes the sale of a property after the property owner fails to pay their tax bill, including property taxes, federal income taxes, and state income taxes.

Individuals who want to invest in real estate can do so indirectly by investing in tax lien certificates at a tax lien auction rather than purchasing full properties with the hopes that they will earn a profit on their investment later.

What Are Tax Liens?

The IRS or a government agency may issue a federal tax lien against a specific property or against all properties owned by a defaulting taxpayer in order to place a legal claim over the asset in the case that the property tax delinquency continues.

The tax lien is documented using a tax lien certificate, and this form can be sold to an investor or a trust through a public auction that allows the highest bidder to purchase the certificate. 

Tax Lien Foreclosure Vs. Tax Deed Sale

Tax lien certificates and tax deeds allow municipalities to secure payment of unpaid property taxes, but there are differences between these approaches.

If a property owner has a delinquent tax liability, the government may pursue a tax lien foreclosure, or tax lien sale, as a method of collecting money.

The other option for securing payment for unpaid property taxes is a tax deed sale.

Tax Lien Sale

The sale of a tax lien to the highest bidder in a foreclosure auction gives the buyer the legal right to demand lien collection from the property owner.

In a situation where the homeowner cannot afford to pay the tax lien and associated interest, the bidder who purchased the tax lien in the sale can then proceed with a property foreclosure as a method of securing payment.

Investors may choose to purchase tax lien certificates in a tax lien sale so that they can earn money through the interest of the tax lien.

Tax Deed Sale

The sale of a tax deed involves selling the entire property to the highest bidder at a public auction. In this situation, the unpaid taxes associated with the property would also be acquired by the buyer in the sale. 

Tax Foreclosure Redemption Period

Sometimes jurisdictions may offer the original homeowner the opportunity to get their property back during a redemption period following the tax deed sale. In this situation, the original house owner must reimburse the purchaser for the amount that they invested in the tax deed.

This  period can range from three months to three years, and during this period,  interest and penalties will continue to accrue on the tax lien certificate. When the debt is finally resolved, the person who invested in the tax lien certificate will be reimbursed their initial investment amount as well as the accrued fees and interest. 

What Happens If The Homeowner Cannot Pay Delinquent Taxes?

If a homeowner cannot afford to pay their property taxes and the IRS issues a federal tax lien, the last resort for the IRS or the person who purchased the tax lien certificate to collect the money owed is to initiate a tax foreclosure.

In this situation, the court will order a foreclosure auction and the highest bidder will take ownership of the tax lien certificate.

Tax Lien Certificates Investing Pros and Cons

Benefits Of Tax Lien Investments

Rate of Return

One of the most attractive potential advantages of investing in tax lien certificates is achieving a consistently high rate of return. Because tax liens usually have precedence over mortgage liens and other types of liens, if the original landlords cannot pay their back taxes, acquiring tax lien certificates can be quite affordable. 

Low Entry Points

Compared to some different types of investment options that require a minimum investment requirement, tax lien certificates sometimes have an entry point as low as a few hundred dollars. This makes the affordability of this type of investment more accessible than other investment opportunities.

Drawbacks Of Tax Lien Investments

Tax Lien Certificate Initial Payment

One of the drawbacks of investing in tax lien certificates is that the investor must pay off the tax lien certificate in full over a short period of time, typically under three days. 

Illiquid Asset

Another reason people may avoid placing a bid on tax lien certificates when considering investment options is that these certificates are illiquid assets, meaning there are no other trading markets to cash in on their value. Therefore, they have limited options to earn back the money they invested.

No Guidance

Tax lien certificates are not always the best investment option for amateur investors as they require significant research to ensure that a property has an appropriate assessed value that has the potential to accrue capital gains. For example, the shape of the property, the city it is located in, and the neighboring areas could significantly impact the potential for the property to be developed and gain value.

If you need assistance determining which investment opportunity is right for you or understanding the tax implications of investing, the experts at Ideal Tax are here to help. Schedule a free consultation with one of our tax professionals today to initiate the process of optimizing your approach to taxes.

Luis Ceja, Author
Luis Ceja, Author

Luis graduated from California State University Fullerton with a B.A. in Political Science. As the Director of Operations at Ideal Tax, he combines years of tax related knowledge with industry expertise, solidifying his prominence in the field.

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