Tax Deed vs Tax Lien – The Difference Between Tax Deeds and Tax Liens

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A tax deed provides ownership of a property to a government body. This legal document can be issued when the owner of the property does not pay any taxes that are due. With the tax deed, the government is permitted to sell the property to collect the amount that is delinquent. Then the property can be transferred to the person who purchased it.

A tax lien is a legal claim against a property that is permitted by the government when you fail to pay a tax debt. The lien protects the interests of the government in collecting the delinquent task in all aspects of property, which includes real estate, financial assets, and even some personal properties.

The key differences between these two legal documents involve which properties are involved. A tax deed involves real estate only. In theory, a tax lien can involve any personal property that you own, which includes real estate.

What Happens with a Tax Deed?

If you own real estate, then you are responsible to pay certain taxes that are assessed by the local government on that property. Those taxes are used to fund sewer access, build water infrastructure, offer public services, and support the community.

Each community or jurisdiction sets their own property tax rates. If the assessed property taxes are not paid, then the taxing authority is permitted to sell the deed to the property, or its title, to take care of the delinquent taxes that are due.

The tax deed transfers legal ownership to the buyer of a property that was sold because of overdue tax obligations. There are several steps the taxing authority must complete before this stage of the process is permitted.

  • The property owner must be notified that the taxes are overdue, and a tax deed is a possibility.
  • The taxing authority must apply for the tax deed.
  • A notice must be placed at the property which indicates it will be sold as a tax deed.
  • A public notice must be posted notifying the community of the sale.

How these steps are fulfilled is in accordance to local laws. Some jurisdictions may require fewer or additional steps to those listed here. There may be certain timing considerations that must take place as well.

When there is a tax deed sale, the property is considered sold. The minimum bid at auction involves the amount of back taxes that are owed on the property, along with interest on that debt, and the costs which are associated with selling the property.

In most tax deed sales, the highest bidder for the property has just 48-72 hours to pay the entire amount that is owed. If they do not, then the sale will be invalidated.

Depending on your jurisdiction, you may still have the opportunity to fulfill a redemption period where the full amount that was paid at auction for the property by the winning bidder can maintain property possession.

If the highest bidder receives possession of the tax deed, then they are awarded the opportunity to begin foreclosure proceedings.

What Happens When You Get a Tax Lien?

A tax lien occurs after there is a liability assessed for your tax responsibilities. Many tax liens are issued by the IRS in the United States. Any government agency responsible for assessing and collecting taxes, however, may have the authority to assess a tax lien on personal property.

Once the balance due has been assessed, you will be sent an invoice which describes how much you owe. This document is called the Notice and Demand for Payment.

When you cannot pay the balance due by the date on the document, or you refuse to pay it, then the IRS will file a public document called the Notice of Federal Tax Lien. This public document alerts your creditors that the government has a legal right to the property you own. This document will appear on your credit report.

The easiest and fastest way to remove a tax lien is to pay off the debt I full. The IRS will release the lien within 30 days of paying the tax debt.

There are other ways to reduce the impact of a tax lien as well.

  • Subordination. This does not remove the tax lien, but it will allow other creditors to take a higher priority than the government. That can make it easier for some households to qualify for certain loans, such as a mortgage.
  • Withdrawal. The government can decide to remove the public notice of the tax lien, which eliminates competition for future creditors on the property. It does not remove the amount due from the overdue taxes.
  • Discharge. This removes the lien from a specific property. There are several provisions in place that allow you to determine which property items are eligible. Refer to Publication 783 for more information about this option.

A tax lien may affect you in multiple ways. It can be attached to all of your assets, including any securities or vehicles you own. It can even be applied to future assets that are acquired while the tax lien is active.

This limits your ability to acquire credit. Although it is still possible to obtain credit, the presence of the tax lien lowers your credit score, which creates higher risks to the lender.

A tax lien will also attach to any business properties you control, including your accounts receivable. It may even continue beyond a bankruptcy filing.

If you cannot pay a tax obligation in full immediately, it is better to arrange payment options than to allow the tax debt to sit.

Knowing the Difference Between Tax Liens and Tax Deeds Is Important

When you are served with a tax deed or a tax lien, the effects can be devastating, both personally and financially.

Investors also have the opportunity to get involved with these items. With a tax lien, you can purchase certificates to earn interest and penalty income. With a tax deed, you’re going to try to secure real estate at a price below the market value of the property by going through the foreclosure process.

With a tax lien, when a property goes beyond a grace period that is in place for a late payment, then interest and penalties are owed on the amount. If no payments are made, then the tax lien is placed on the property.

Communities don’t want to hold tax liens. That’s why they sell them as a certificate to investors. When an investor purchases a tax lien certificate, they are paying the debt of the property owner. That gives the holder of the certificate the right to any interest and penalties that are collectible. To remove the certificate, the property owner must pay the investor the full amount you paid for the certificate, plus the interest and penalties.

Let’s say you purchase a tax lien certificate at $2,000. You earn $85 in penalty income and interest income of $210 on the certificate. The property owner must pay you $2,295 to clear the certificate.

That means you profit $295 from the investment. In most cases, a tax lien certificate is usually cleared within 2 years.

If the property owner doesn’t pay off the certificate, then you have the right to foreclose on the property after all legal periods for redemption have expired. Should that happen, in this example above, you’d earn the right to own the property for the initial bid for the certificate and your legal costs for foreclosure.

Tax deeds are a little different. You purchase a tax deed from the government who is auctioning off a property to pay off a debt. Once you own the tax deed, then you can foreclose on the property if the owner doesn’t pay off the debt.

If there is a redemption period allow, then you’re able to earn interest and penalties on the amount.

The goal with a tax deed purchase is to gain equity profits. Let’s say that a property is valued at $100,000. There is an existing amount of $6,100 in back taxes, interest, and penalties owed. As the investor, you are able to purchase the property at auction for $49,000.

The government is only interested in the taxes that are owned on the property. From your winning bid, the first $6,100 goes to the taxes. You’re given the title free of encumbrances in most jurisdictions. The property owner would receive $42,900, which would probably then go to their mortgage lender.

You would receive the equity profit of $51,000 for the property.

How to Know if a Tax Deed Sales Is the Right Option

Different liens have different priorities when assigned to a property. In many circumstances, but not all, a tax lien has the highest priority over other liens. In a tax deed sale, the other liens are cleared off.

Certain liens are a higher priority than a property tax lien. Investors will need to check a potential property for delinquent child support liens, IRS liens, and civil liens from court judgments. If you purchase a tax deed with these higher liens in place, you will inherit the responsibility of the debt, even though it is not yours.

Tax deed sales are almost always a buyer-beware purchase. You must perform your due diligence before making any bid, ensuring the title is fully investigated before purchasing the property. That will avoid having you pay unexpected debts or face having your own lien collection issues in the future.

If your lien is subordinate to another claim, you may even be forced to surrender the title to the property.

For that reason, many investors prefer to purchase tax lien certificates instead. Although the potential investment value is much less, there is less risk of losing the investment as well. Most tax lien certificates are also sold via auction, though some may be available from the local jurisdiction which has issued them.

Instead of bidding on the price, however, investors bid on the interest rate they are willing to receive. The investor with the lowest interest rate bids typically wins the auction and is issued the tax lien certificate.

Some states permit the auction to involve bidding on the premium of the lien instead. The bidder who offers the highest premium above the lien amount then wins the auction. That premium can then earn interest and could be paid back to the lienholder at redemption, but that does not always happen.

A tax lien certificate ranges from 1-3 years in most circumstances. Although obtaining ownership through foreclosure is possible with a tax lien, most certificates are redeemed long before a distressed property reaches that state.

A Final Thought on Tax Deeds vs Tax Liens

If investing into either tax deeds or tax liens, you must consider the value of the property itself. Some properties have little value to them, which eliminates the desire of the owner to clear the debt.

You might find a nice ¼-acre parcel with a good potential tax lien certificate or tax deed, but if the property is 2 feet wide and 1 mile long, you’re not going to be able to do much with that property.

Pay your property taxes as soon as possible if you own real estate. Clear any tax responsibilities to avoid a tax lien. Make payments, if possible, or settle the debt if you can. For investors, perform your due diligence before making any purchase to ensure you get the best possible return.