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A tax deed is a legal document that gives a government body the right to sell a piece of real estate for non-payment of taxes. When a real estate owner gets behind on property taxes, the city or county may place a tax lien on the property. If after a period of a few months or a few years, depending on jurisdiction, the owner doesn’t pay the amount owed the local government can sell the tax deed to the property at an auction. That creates an investment opportunity. Here’s what you need to know about such an opportunity. If you’d need hands-on guidance in consider a tax deed to invest in real estate, consider enlisting the help of an expert financial advisor.

Tax deed investors buy these tax deeds at auctions. The money the highest bidder pays goes to local government to recoup the lost tax revenue.

It’s possible to acquire properties for significantly below market value through tax deed auctions. This can lead to handsome returns for successful tax deed investors.

Nearly any type of real estate can be acquired by investing in tax deeds. Residential, commercial, industrial and raw land can all be found at tax deed auctions.

Tax Deed vs. Tax Lien

Despite the similar names, tax deed investing is very different from tax lien investing. Both involve bidding at auctions held to compensate local governments for unpaid property taxes.

However, with tax deed investing, the successful bidder immediately gets title to the property. Tax lien investors aren’t acquiring title to any real estate. Instead, they’re buying the right to receive interest payments on the amount owed to the taxing authority.

Tax deed auctions are overseen at the local level and governed by a variety of state, city and county rules, regulations and laws. Only some states allow tax deed sales. Others only allow tax lien sales. Some operate a hybrid system combining both approaches.

Successful tax deed investing requires knowing local laws and procedures as well as local real estate markets. These complications and the risks keep many inexperienced real estate investors out of tax deed investing.

How Tax Deed Investing Works

Real estate auction signProperties wind up at tax deed auctions, because the owners did not pay property taxes. After a period of time that varies according to jurisdiction, the taxing authorities can place a tax lien on the property. After further time, the government can foreclose on the property and auction it.

Local governments post lists of foreclosed properties before the sales. Investors can obtain these lists, research the properties and decide where to submit bids.

Auctions are often held online but may also be offline and require bidders to be present. Auctioneers typically set a minimum bid of the total of unpaid taxes, penalties and interest. Sometimes the minimum bid is set as a percentage of the market value.

The winning bidders are expected to place a down payment at the time of the auction. Then they pay the rest in cash, often within 24 hours but in some jurisdictions up to a few weeks later.

The taxing government takes the back taxes from the amount paid by the highest bidder. The rest, if there is any, usually goes to the mortgage lender.

The title to the property also must be cleared or cured after a tax deed sale. Curing the title can involve a title certification process using a title insurance agent, or a type of lawsuit called a quiet title action that removes other claims to ownership.

Once the title is cured, the new owner can begin realizing financial returns. Properties acquired through tax deed auctions are often fixed and flipped. They can also be resold as-is or rehabbed and kept for rental income.

Risks of Tax Deed Investing

Modern house with swimming pool

A major risk of tax deed investing is paying too much. Tax deed auctions may attract lots of bidders and it’s easy to overpay.

Also, tax authorities may not allow inspection of the properties before the auction. Unexpected repairs can eat up an expected profit quickly.

Some states have a redemption period of up to a year or more after the auction during which the former owner can pay off the tax bill and regain ownership. This possibility, which happens often, is another risk of tax deed investing.

Few listed properties actually make it to auction, however, because the owners usually settle the tax bill beforehand. The risk of investing time and energy researching properties without ever being able to bid on them is one of the risks of tax deed investing.

Even when successful, tax deed investing also takes considerable time, effort and research. This can make the final returns unattractive compared to alternative investments.

The Bottom Line

Tax deed auctions let investors acquire real estate that has been foreclosed because of unpaid taxes. Properties can be purchased at significant discounts to market value, but the complexity and risks of tax deed investing are also significant.

Tips for Real Estate Investing

  • Consider talking to a financial advisor if you are interested in investing in real estate with tax deeds. SmartAsset’s free tool can match you with up to three local financial advisors, and you can choose the one who is best for you. If you’re ready, get started now.
  • There are other ways of investing in real estate than using tax deeds. Some of these are REITS, “house hacking” and flipping. Of course, real estate shouldn’t be the only type of investment you have. Getting the right balance of asset types in your portfolio can be accomplished by using an asset allocation calculator.

Photo credit: ©iStock.com/AlexRaths, ©iStock.com/KLH49, ©iStock.com/Eak8dda

 

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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