“We don’t pay taxes. Only the little people pay taxes.”
– Leona Helmsley
The Business of Unpaid Real Estate Taxes
Mortgage holders do pay taxes. Property taxes come right out of an escrow account held by the mortgage company, which the homeowner funds through monthly mortgage payments.
But some people do not have mortgages, and neglect the property tax bills. And some lose income or become overwhelmed with debt, so they default on their mortgage payments — including the tax portion.
When a homeowner doesn’t pay taxes, the government has a number of ways to recover its money. Depending on state law, it can place a lien on the title, or it can sell the house to recover the taxes — using a tax deed.
Below, we’ll look at tax liens, the use and abuse of tax liens, and tax deeds.
The Tax Lien, and Its Impact on Title
When a homeowner doesn’t pay property taxes or real estate transfer taxes, the tax agency can go to court and record a tax lien. The lien is a claim on a portion of a property’s value. It doesn’t mean the home has been seized. But a lien can be seen by anyone who runs a title search on the home, because it is publicly recorded with the county. This means mortgage companies, banks, and credit unions have access to the information.
A property with an unresolved tax lien can’t be refinanced or sold. The government’s claim gets priority, and must be resolved first.
The homeowner should get an official lien payoff request form from the state to start the process. Once the payoff process is complete, the homeowner gets a lien satisfaction notice by mail.
Beware of Property Lien Scams
Fake property liens exist. They’ve been around for years. The scam works like this. The homeowner gets a tax statement in the mail from the “Tax Enforcement” or some other made-up name. To appear believable, it might mention a real agency — such as the IRS. The notice declares a lien is being placed on the home. A supposed total of overdue taxes appears.
When receiving such a notice, a homeowner should check the government’s website to see if overdue taxes show up on their account page. If the letter is bogus, the homeowner should report the scam.
States are also impersonated by lien scammers. Pennsylvania, for example, notes this issue on its website. When a real tax lien is filed with the homeowner’s county, Pennsylvania mails the homeowner a document called the Certified Copy of Lien letter. Pennsylvania has agreements with law firms (it names Wong Fleming and Linebarger Goggan Blair & Sampson), so letters may be on corporate letterhead.
Unsure a government lien letter is legit? Look up the tax agency’s phone number on the web. Then call it and ask.
How Tax Liens Become Investment Products
In some states, tax lien certificates, representing the value of the liens, may be auctioned off to investors. These investors pay the taxes and the accrued interest and fines, and then hold the liens themselves. The investors are entitled to a regular stream of repayments from the homeowners.
The higher the interest rate on the liens, the bigger the profit for tax lien investors. Competitive bidding by institutional investors pushes the yields down, so it’s difficult for ordinary investors to achieve large returns.
In any case, getting the returns always depends on the homeowners actually paying the debts. What if the homeowner doesn’t pay off the back taxes? Then, the investor must initiate foreclosure on the property in order to get the title, sell it, and receive value for it.
After a given number of months of not getting paid (state law dictates the timeline), the investor notifies the homeowner of their claim on the property. The investor may initiate foreclosure if repayment does not occur during the redemption period, which is typically anywhere from one to three years.
The tax lien investment process extends the time a homeowner gets to satisfy their tax debts. In this sense, the lien investment sector frames itself as helpful to homeowners. Usually, the owner manages to pay back the taxes before the redemption deadline.
Still, investors have to know something about the properties they’re getting into, what they’re actually worth, and even the history of the land and surrounding area. There’s always the risk of getting stuck with the tax debts, the mortgage itself, other liens and claims, the property, or environmental hazards.
Obviously, a tax lien can be a messy investment and a risky bet. Some state and local governments bar this kind of investing. Where it’s allowed, investors may invest through funds, rather than in individual properties. The National Tax Lien AssociationTM explains the social value of lien investing this way:
Without tax lien sales, local governments would need to charge higher interest rates on delinquent accounts and send them to foreclosure faster. Instead, through tax sales the local governments get the cash they need immediately…
Those willing to do the research to invest carefully can start by vetting the broker online.
How a Tax Deed Differs from a Tax Lien
As we’ve noted, tax liens aren’t allowed everywhere. In some jurisdictions, the government is the party that forecloses, using a tax deed. For example, Pennsylvania is a tax deed jurisdiction. The government seizes the home if the owner cannot pay real estate tax.
A county tax assessor is empowered to issue a tax deed if a homeowner can’t pay an overdue tax bill. Next step? Putting the home up for public bidding — online, or on site. Auction proceeds go to cover the unpaid taxes. Extra proceeds go back to the former homeowner. In other words, the homeowner gets paid whatever the auction brings for the house — minus the taxes due. Then the property’s title is conveyed to the successful bidder.
What do the bidders do? Usually, they flip the properties. Some hold onto to them as rentals, and some buy these properties to live in. Bidders want properties that do not have other liens to satisfy, so they look for judicial sales. Note the process as it’s carried out in Montgomery County, Pennsylvania. Investors should know one very important point. While investor groups say that courts reissue tax sale titles free of mortgages and other liens, there is no warrantee or guarantee on a tax sale deed.
Also, note that the original homeowner has window of time under state law to show up and redeem a property sold at a tax sale. Looking again at Pennsylvania, the law allows redemption up to nine months after the sale, according to the Municipal Claims and Tax Liens Act.
A further potential pitfall is the condition of the house. If the former owner could not pay the property taxes, is the home likely to be in good repair?
Key Takeaways
Each state has its own laws on what’s allowed: tax liens, or tax deeds. Counties within each state also have their own sets of rules. Some governments have shifted from tax deed sales to lien sales. This shifts responsibility for foreclosure to the private investment sector. The selection is a matter of public policy.
Tax lien certificates are bought by investors. Groups can pool their investments by investing in tax lien funds. The fund managers have to follow up with the homeowner to get repaid, with interest, and distribute the profits to the investors.
With tax deeds, the entire home is sold — not just the value of the debt. Tax deeds are active investments. The successful bidder for a tax deed has to actively manage the property — whether than means flipping it, renting it, or living in it.
Tax liens and tax deeds can have pitfalls for novice investors. We cannot give legal or financial advice to individuals. As a general matter, everyone should tread with caution. Always get expert guidance before putting hard-earned funds at stake.
Supporting References
Time: Top 10 Tax Dodgers – Leona Helmsley (Apr. 2022).
Rebecca Lake for The Balance: What Is a Tax Deed? (updated Feb. 3, 2022).
Pennsylvania Department of Revenue: Tax Liens – What Is a Tax Lien?
Pennsylvania Statutes Title 53, §7293(a): Municipal Claims and Tax Liens Act, Right of Redemption.
U.S. Internal Revenue Service, IRS Tax Tip 2019-134: Taxpayers Should Beware of Property Lien Scam (Sep. 26, 2019).
Sarah Foster and Dan Kelley for Bankrate.com: Tax Lien Investing Is Risky for Most Investors. Here’s What You Need to Know Before You Jump In (Sep. 10, 2021).
And as linked.
Photo credits: Mikhail Nilov, via Pexels.