An image of a person holding a gavel. Tax lien and tax deeds go to auction

Tax Lien Certificate vs. Tax Deed: The Key Differences

Sometimes property owners just can’t keep up. Whatever the reason, their property taxes don’t get paid. The municipality the property resides in needs these funds. So the government turns to investors in one of two ways: a tax lien certificate or a tax deed. Whether investors get a tax lien vs. tax deed depends on where they live. There are similarities, but there’s a big difference between investing in a tax lien versus investing in a tax deed.

Tax liens and tax deeds can be a more advanced investing strategy. Keep reading to find out how they differ, and what they offer to investors.

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Tax Lien vs. Tax Deed: The Similarities

Property owners typically pay off their property taxes with their mortgage. But, some owners fall short and don’t pay their tax fees. So the city or county government needs to collect that debt in another way.

These municipalities will turn to investors to pick up the slack and provide a solution to the problem. At their core, tax liens and tax deeds are debts that need to be paid and depending on the location, these debts will go on auction, either monthly, quarterly, or annually. Either way, investors are investing in the debt of the property owner, but that’s where the similarities end.

An image of the word taxes. It's important to know how a tax lien tax deed are created.

Tax Lien vs. Tax Deed: The Differences

When investors win the auction for a tax lien, they are only buying the debt that is owed for the property taxes. This means that liens are a strategy where an investor isn’t actually acquiring a property. Investors pay the tax debt for the property owner, which in turn means the property owner needs to repay the investor plus interest. This is how the investors make a profit.

Tax deeds, on the other hand, are where a real estate investor bids on the actual property deed. Unlike liens, the investor who wins the tax deed will now have ownership of the property. Tax deeds do not have a specified rate of return. And note that some states do allow a redemption period for the property owner to buy back the deed.

Tax Liens: What You Should Know

As mentioned, an investor wins a tax lien certificate through an auction and collects interest on the money he or she spent to acquire the certificate. What’s important to know is that tax lien auctions are done in a bid-down fashion. And investors are bidding on the interest rate. 

States that allow tax lien auctions have a maximum level of interest they can put on tax liens. For example, Maryland and Florida have a maximum interest rate of 18%, while Colorado is at 10%. From there, investors bid down the interest rate, and the winning bidder is the investor willing to accept the lowest interest rate.

Investors are only paying for the debt that the property owner owes. Because of this, and the bid-down auction-style, an investor can acquire a tax lien certificate for as little as a few hundred dollars. This provides the investor with the opportunity to bid on multiple tax lien certificates at a time.

Tax lien certificates prevent the property owner from refinancing or selling his or her property, as they take precedence, even over a mortgage payment. If in the event the property owner does not pay back his or her delinquent fees, as the lienholder, the investor can foreclose the property. However, this rarely happens.

Tax Deeds: What You Should Know

Tax deeds auctions run like a typical auction—the deed goes to the highest bidder. Again, investors bid for the deed of the property in addition to the debt owed. Because of this, one will more than likely pay more than the debt owed, especially in competitive real estate markets.

States that auction tax deeds may also have redeemable deeds. This means that if the state has a redemption period, the property owner and any other invested parties have an opportunity to pay their taxes back to the investor. This means that they can reclaim their property from the investor.

If the redemption period expires, and the property owner has not paid the investor back, then the investor can proceed to foreclose on the property. Note that it’s a common courtesy to let the redemption period expire before moving forward with plans for the property.

If the state does not have a redemption period, the winning investor can remove claims to the property, and then the property is conveyed to the investor. The investor is then free to do what they will with the property.

Since the government is only interested in the tax being paid, tax overages from the auction go to the original property owner.

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Do Your Research

Investing in a tax lien or a tax deed may seem simple, but it isn’t a strategy for beginners.

Due diligence is required for both liens and deeds. It’s recommended that investors need to know their market area and the market value of the properties there. Tax liens are ideal for investors who don’t want to take on a property. But beware, investors shouldn’t want to invest in the property owner’s debt if the taxes and interest are greater than the market value of the property. This could mean the owner would be less motivated to pay back the debt, forcing the investor’s hand to foreclose and take on a property.

Tax deeds are the same. Knowing the market value of the property and comparing it with the taxes, as well as what you might pay for renovations and the after-repair-value (ARV) is critical. The property you receive will come to you in “as-is condition,” so keep that in mind.

Location, Location, Location: Tax Lien States & Tax Deed States

Whether or not you can bid on a tax lien or a tax deed depends on where you live. Some states will only allow tax liens, while others only allow tax deeds. And amongst these tax deed states, there runs a further divide between states that have a deed redemption period and states that don’t.

States such as California, Washington, Wisconsin, and Michigan are tax deed states. Louisiana, Arizona, Illinois, and Colorado are tax lien states. States such as Texas, Georgia, and Tennessee are redeemable deed states. Florida, New York, Ohio, Pennsylvania, and Nevada are states where investors can bid on both liens and deeds. In these states, the delinquent fees will start out as tax liens, then transfer into tax deeds after a certain period of time.

Ready to Get to the Auction?

In the end, tax deeds and tax liens can be a more passive form of investment—after the bid has been won and everything has been set up. But the due diligence process leading up to the auction can be tedious and time-consuming. Investing in tax lien vs tax deeds isn’t usually recommended for beginners.

Having said that, tax liens are a good way for investors to invest in real estate without having to own a property, similar to wholesaling. They have a low entry threshold because all the investor is doing is paying off a property owner’s taxes. The money collected is pure interest, as the owner pays the investor back. Tax deeds are also good for investors who are looking for properties to rent or rehab. It’s likely that investors will pay more than what the property owner owes in taxes, but the investor can acquire the property below market value. 

Tax lien certificates and tax deeds don’t have a secondary market. However, upgrading to a premium membership on MyHouseDeals gives members of our tribe access to on-demand training. These trainings include strategies that have a tax lien or deed focus, and much more. This investing strategy is worth looking into to help investors diversify their portfolios and find properties in ways they maybe hadn’t considered before.

Happy (and profitable) investing!

Posted on Mar 5, 2021

Author: Alex Farris Soares

Alex is President of MyHouseDeals. Since 2006, he’s worked with real estate investors to bring them the marketing services and training they need to elevate their businesses and reach their goals. Alex is an avid customer advocate, enjoys affecting change in the REI and digital marketing industries, and promotes the values of entrepreneurship and innovation.

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