What is a tax deed auction and how does the auction process work?
First, let's go over what exactly a tax deed is. Anyone who purchases a home is responsible for the taxes to the county in which they live. Homeowners pay these property taxes once or twice a year, with the amount owed depending primarily on which state they reside in. If property taxes aren't paid on time, then their county will usually place what is known as a tax lien on their property. The owners will then have a set time period to pay the owed taxes. However, if they fail to pay, a tax collector can then sell their home through a public tax deed sale.
In Texas, in the tax deed sale, the starting price will be equivalent to the back taxes owed on the property at the time of sale. That includes delinquent taxes, interest charges, penalty fees, legal costs, and administrative charges and fees. Then, the property is auctioned off and sold to the highest bidder, and the purchaser acquires the rights through the county, taxing entity, or taxing unit. The restrictions on bidding at these sales are minimal: You don't even have to be a real estate agent or a professional investor. It's important to keep in mind that you typically will need to pay the bid amount in a short period of time, so you should have the liquidity to cover your purchase and cannot be delinquent on any taxes in the county yourself.
The bid amount will usually be made up of:
- Delinquent Property Taxes
- Interest Charges
- Penalty Fees
- Legal Costs
- Administrative Charges and Fees
When tax deed is sold, the purchaser acquires the rights held by the county or taxing unit. Tax sales may be held monthly, quarterly or annually. There are very few restrictions regarding bidding at these sales (i.e., you do not have to be a real estate agent, professional investor, etc.); however you usually must be able to pay the bid amount within a short period of time and you cannot be delinquent yourself in taxes, in that particular county.
After the sale and for a specified period of time the delinquent taxpayer has the right to buy back or “redeem” the property. This is called the right of redemption. In many cases this redemption period may be as short as 180 days (for certain property types in Texas). If the delinquent taxpayer does not redeem the property during the specified time, then the successful bidder is entitled to the property regardless of the purchase price. Let me say that again: the successful bidder would be the owner of the property even if it was bought for $15,000 and it has a market value of $150,000!
That sounds great, but what happens if the delinquent taxpayer decides to exercise their right of redemption? Does the investor lose the money they spent at the action? No not at all! In that situation the delinquent taxpayer must pay the investor an interest penalty charge in order to “redeem”. This interest charge could be as high as 25% or even 50% (for second year redemptions). What this means is that the investor will generally get back the original investment plus the interest penalty charge. The delinquent taxpayer will get their property back.
What Happens If the Delinquent Taxpayer Does Not Redeem?
For a specified period of time after the sale, the taxpayer has a right of redemption to buy back the property. This period can be as short as 180 days, but you'll need to check the local laws in the county where the public auction is taking place. If the taxpayer does redeem, you will generally receive the amount of money you spent on the auction back, in addition to an interest penalty charge, which means you can still profit on the transaction even if the right of redemption is exercised. Keep in mind that the interest charge could be as high as 25 or 50 percent, so your earnings could be substantial.
If the property is not redeemed, then the winning bidder can buy the property at a Texas tax deed sale or any Texas tax lien sales. It may seem too good to be true, but when the original owner does not fulfill the terms of the redemption, as the successful bidder, you would be entitled to the property regardless of the purchase price that you paid. That means in some cases you can get incredible deals on valuable properties, like paying only $15,000 for a $150,000 home. Considering how valuable some properties in Texas are, this is no small thing.
While there are some tax deed states and some tax lien states, Texas uses a hybrid model, which incorporates some aspects of each system. When you have a successful bid at an auction, you will obtain the tax deed which gives you full responsibility for the property. Still, the winning bidder is not guaranteed eventual ownership due to the right of redemption, which is more commonly found in tax lien states. In Texas, the redemption period tends to be around 180 days or four months.
Is Texas a ‘Tax Deed' State or a ‘Tax Lien' State?
Texas is a ‘hybrid' state. NOTE: You won't find that word in the Texas Property Code. This means that the state combines the some of the aspects of the tax lien states and some of the aspects of the tax deed states. For example, in Texas the successful bidder obtains a tax deed at the auction. The tax deed gives the purchaser FULL RESPONSIBILITY for the property. This is very similar to the process in traditional tax deed state. Nevertheless, in Texas the winner bidder is not guaranteed eventual ownership of the property. This is because the delinquent taxpayer still has a redemption right. This is very similar to the procedure in a tax lien state. If the delinquent taxpayer wishes to redeem, they must pay a penalty return within a certain amount of time to “redeem”. Generally, in Texas the period is either 180 days or 24 months. The amount of time will depend on the type of property that is sold at the tax sale. Investors who want the shorter redemption time period (i.e., 180's will target certain types of properties at the tax sale).
Why are the tax laws in Texas considered favorable to investors?
You may be wondering why we recommend tax deed auctions in Texas, rather than those in other states. The specifics of tax law, specifically regarding auctions, are extremely favorable for investors. For example, the interest rate in Texas is one of the highest in the country should the taxpayer redeem the property. Typically, taxpayers are given a one-year redemption period, where you would receive a 25 percent penalty fee. In rare cases, they may be given two years to pay, but the fee if they don't increases to 50 percent. This represents one of the highest rates of return in any tax deed or tax lien state. The redemption amount is based on the price paid at the auction by the investor, not the original opening bid, in addition to including all fees and costs owed by the taxpayer.
Texas also uses what is known as a “full interest penalty return” system, where taxpayers must also pay the interest on the price dictated by the winning bid. In tax lien jurisdictions, a quick redemption can result in as little as a 1 percent return for the investor. The sales are conducted on the first Tuesday of every month, giving investors multiple opportunities to obtain property every year. The size of the state is another advantage, as each of the 254 counties in Texas conducts tax deed sales. After auctions, you may find opportunities to purchase unsold properties, many of which do not even require a redemption period.
To dig in a little deeper, here are 9 specific reasons why Texas is such a great Tax Sale State.
1. At Interest Rates of 25% to 50% Texas Provides the Highest Profits if a Redemption Occurs: In Texas, if the delinquent taxpayer wants to obtain their property after your purchase at sale they must pay you either 25% (for first year and 180 day redemptions). In some situations a 2 year redemption will apply, but don't worry because in this situation the investor is paid a whopping 50%! This represents one of the highest rates of return available in ANY tax lien or tax deed state.
2. The Redemption Amount is Calculated Based Upon the Price the Investor Has Paid at Auction: This is an astounding aspect of the Texas procedure! For example lets assume that John attends a tax sale in Harris County:
John researches a property which is scheduled to sell at a Harris County tax sale. The opening bid for the property is $5,000. The property is offered for sale and is bid up by other investors who are also interested in the property. John takes part in the bidding and wins the property for $15,000. One month later the delinquent taxpayer, Sheila contacts John and informs him that she would like to “redeem” the property. Sheila will have to pay John a 25% penalty calculated from the $15,000 that John paid at the tax sale NOT the original opening bid price of $5,000!
As you can imagine this presents a significant return for John, because he is earning interest on all the funds invested including the overage he paid due to the competitive bidding. If the property has a market value that is reasonably higher than $15,000 (and proper research was conducted) then John cannot lose. He would have either obtained the property for cents on the dollar or obtains a 25% or 50% return on his investment. While most tax lien states are paying 2% to 5% in interest to the investor, Texas still pays a FULL 25% to 50% on redeemed deeds.
3. Additional Fees and Costs Are Included in the Amount Required for the Delinquent Taxpayer to Redeem:
According to Chapter 34.21 (b) of the Texas Tax Code:
The owner of real property sold at a tax sale may redeem the property by paying the purchaser:
- The amount the purchaser bid on the property
- The amount of the deed recording fee
- The amount paid by the purchaser as taxes, penalties, interests and costs on the property, and
- The penalty return amount
What this means is that the investor will also obtain the penalty return (i.e., 25% or 50%) on the deed recording fee, the amount paid to preserve and maintain the property and any later taxes paid on the property. For the investor this represents a significant return with very little downside. Impressive to say the least.
4. Texas Uses a Full Interest Penalty Return System Unlike the Majority of Tax Lien States: In Texas, if the delinquent taxpayer wishes to redeem the property, they must pay a full interest penalty calculated from the final price paid by the investor at the auction. For example, if the delinquent taxpayer wishes to redeem the property 3 weeks after the tax sale, they must pay the full 25% return in addition to the costs and fees described above. This is very different than most tax lien jurisdictions in which a quick one month redemption might total a modest 1% in interest or even less!
The same rules would apply for a $100,000 dollar investment in which the delinquent taxpayer redeemed quickly. A full 25% return would be earned on the $100,000. Now the $125,000 could be re-invested back into the Texas tax sale system for even greater returns. Combine this with a tax-deferred, tax-free IRA and the results are nothing short of staggering!
5. Texas Has Monthly Sales: The vast majority of tax lien states have rapidly eroding interest returns and annual sales which herd investors into a giant yearly tax sale. This can create excess competition, confusion, and limited opportunities for investment. Texas statutes allow counties the option of utilizing monthly tax sales. According to Texas law, the tax sale may take place on the first Tuesday of the month. This can provide the investor with numerous opportunities to invest in the Texas system many times during a given year.
6. Texas Has 254 Counties and Each Will Conduct Tax Sales: Texas also has a vast number of counties 254 to be exact. Not every county will have monthly tax sales. Generally, only the larger counties will hold sales every month. However, the smaller counties offer the benefit of infrequent tax sales which can lead to lessened competition. Also the smaller counties have lists of properties which were once offered at tax sale, but for whatever reason did not sell. These are called strike off properties and will be discussed below.
7. Numerous After Auction Opportunities: Under Texas law, counties may choose to sell unsold tax sale property at a later sale or offer them for sale after the sale. These are generally called strike off properties. The advantage of these types of properties is that they are available for purchase (in most counties) at any time. Also the investor may offer less than the back tax amount in some situations. Lastly, depending on how much time has elapsed since the original tax sale, many of these properties will not have a redemption period. So for the investor with hopes of obtained full title to a property, strike off sales can present meaningful opportunities.
8. The Texas Tax Deed is a Super Priority Lien According to Texas Statute: The Texas tax lien is referred to as a super priority lien. This means that it generally has priority over nearly every other type of lien, debt, claim or charge that may be attached to a property. Thus the purchaser (if proper research has been conducted) can in most cases obtain the property clear of most liens and encumbrances. Research is very important, and the investor must verify that legal notice has been sent to all affect parties.
9. The Tax Sale Investor Also Has Rights to Any Rental Income Derived From a Tax Sale Property: At the time of this writing, Texas law allows the successful bidder at tax sale to collect any rents from the property immediately after the tax sale. If a property is occupied by a tenant then the investor might choose to leave the tenant in the property or evict. If a suitable tenant is in the dwelling house, then this can represent a significant source of cash flow.
What research needs to be done prior to purchasing property?
Texas tax liens are given what is known as “super priority” over other liens. With proper research, you can often obtain the property free and clear of most liens and encumbrances. As the investor, it will be your obligation to send a legal notice to all parties. Unlike other states, Texas provides investors with a guarantee that they will receive all rental income derived from a tax sale property. If the property has a tenant when you purchase it, you can choose whether or not to evict or collect rent. Research will play a major factor in your ability to succeed at profiting through tax deed auctions. You should always understand which liens will survive foreclosure, like state liens and homeowner's association liens, in addition to federal tax liens. The federal government will pay you whatever you paid for the property if you win it as a Texas auction.
Given the high likelihood of obtaining a title to the property, you should always view it before you make your bid and learn everything you can about the home. Find out what other fees may not be included in the foreclosure. When a taxing entity is owed money that isn't included in the foreclosure lawsuit, that amount will not be included in the purchase price, and the investor will be responsible for the fees. Since you will be personally liable for the property if you purchase in your own name, you should always avoid doing so. Finally, remember that you have sole possession of the home immediately after the sale, so you'll need to insure and protect the property right away. Lock doors, obtain insurance, and evict any hostile tenants as soon as you're able to.
There is a lot to learn before you start bidding at tax deed auctions for yourself, but it's worth it to educate yourself before you take the plunge. If you want to make a profit through tax auctions, it's essential that you know how to target the right properties, what costs you'll be responsible for, and how to secure them after you've placed the winning bid. Every state has a different tax code, but Texas is one of the most advantageous for tax sale purchasers. Research is your best weapon when it comes to getting an edge at a competitive tax auction, so take the time to become an informed investor before you head to the auction house.