Investing in Tax Deeds and Certificates

You've no doubt heard of property being sold for the back taxes owed on it, often for pennies on the dollar. If you haven't, simply stay up late one evening and keep your television on; you'll probably run across at least three or four infomercials touting someone's secret method of quickly getting rich by buying and selling such properties. This method of real estate investment - just one of many ways available to invest in real estate "paper" -- as you probably suspected, is not quite as easy or risk-free as they so confidently make it seem.

Paper real estate investment is a huge and diverse field. Besides the time and effort necessary to locate and analyze properties, the one big difference that distinguishes investing in paper from traditional real estate ownership is control - or in this case, the lack of it. When you put your money into paper real estate, as with buying stocks, you are no longer in absolute control of your investment. When you own stock, although you have an equity stake in the issuing company, your investment is at the mercy of corporate leadership and management, as well as the performance of the organization as a whole. Similarly, owning real estate paper subjects your investment to a myriad of government entities and regulations on the federal, state and local levels. You can't just plunk down your money for a tax certificate, for instance, and immediately begin doing whatever you'd like with the subject property. The system doesn't work in that manner.

Perhaps the most common - or at least, the most well-known - area of all paper real estate investments is that of purchasing tax deeds or certificates at real estate tax sales. Although many investors have certainly made substantial amounts of money in this field, as stated previously, it's not extremely easy, it's not risk-free, nor is it always a particularly quick way of turning a profit. But, of course, it can be done. Let's take a look at the basics of this method of real estate investing.

To begin with, it's important to know that tax liens take precedence over all other liens, and governments at all levels (federal, state, and local) can and do seize and sell property for unpaid taxes. But there are rules and regulations that must be followed (lots and lots of them); and to make things even more fun, they're different in each state. For example, some states issue tax deeds, while others issue tax certificates when a property is seized and sold for back taxes.

In states that provide tax deeds to the tax-lien buyer, the deeds are issued at the tax sale auction (although sometimes they're held unrecorded). Deeds either wholly or conditionally transfer title to the subject property from the tax-delinquent owner to the successful bidder. In cases where the portion of property taxes is not paid along with the monthly mortgage payment (a PITI, or principal-interest-taxes-insurance, payment), the successful bidder is most often the first-mortgage holder. Furthermore, federal statutes provide that if government-insured financing (an FHA loan, for example) is in place on a property that's sold at a tax sale, the government agency has one full year in which to redeem it. In other words, don't count on moving in or immediately selling such a property the day after you purchase it at the auction.

In some states, after the tax deed has been issued, the successful bidder must then contend with the state's statute of redemption, which is a law that allows the delinquent owner to reclaim the property by paying all back taxes, expenses, and accrued interest within a specified period of time. In most states, all lien holders of record must be served notice, and they are also given the opportunity to redeem the property prior to the expiration of the redemption period. Once the deed is actually issued to the new owner, all prior liens are extinguished.

In those states that issue certificates, forfeiture of property for tax delinquency does not convey ownership to the subject property. Instead, a tax-lien certificate creates a first-priority lien on the property with the right of foreclosure - again, subject to the state's statutory right of redemption.

The buyer of the certificate pays the outstanding tax and other expenses. He or she must then wait through the redemption period. In order to redeem the property during that time, the delinquent owner must pay the certificate holder the full amount that was paid for the tax certificate, along with interest and sometimes expenses and penalty fees. The interest rate on tax lien certificates is set by each municipality and is often quite high, typically in the range of 15- to 20 percent, and can sometimes be even higher. If the tax-delinquent owner or another party with a possible legal interest in the property (such as an ex-spouse, an heir or perhaps a contractor holding a mechanic's lien) does not redeem the tax certificate within the allotted time, the certificate holder must then initiate foreclosure proceedings. These proceedings are the means by which title will actually convey to the certificate holder.

However, even when foreclosure proceedings are complete, there still may be claims against the property or other problems in getting clear and marketable title. If this occurs, the investor must go to court for a "quiet title" action (which is a court procedure to establish ownership of real property when it's under dispute). If the court's decision favors the certificate holder, then he or she will receive clear title to the property; if it rules differently, he or she will lose the real estate and all money that's been invested in it.

Many people who invest in tax certificates have absolutely no plans to take over ownership of their subject properties. They buy the certificates to take advantage of their high interest rates, with the full expectation that the delinquent owners will redeem them. However, tax certificate holders do face the risk of time and money that would be required to refurbish and resell the property if the owner does not redeem it. But many investors don't look at that as much of a risk considering the very high profit potential in a property bought for no more than the amount of the unpaid taxes.

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