What Is a Tax Deed?

Tax Deeds Explained

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A tax deed is a legal document that conveys ownership of a property to a government if the property owner fails to pay property taxes. This allows the government to sell the property and recoup the taxes it is owed.

If you own a home and you're wondering what could happen if you fall behind on property tax payments, read on to understand how tax deeds work. You’ll also learn how tax deeds are used as investment tools.

Definition and Example of Tax Deed

A tax deed allows a government to claim ownership of a property when the property's owner fails to pay required property taxes. Tax deeds can apply to personal residences, business premises, or undeveloped land.

The purpose of tax deeds is to allow local tax agencies to recover unpaid property taxes. These taxes are used to fund government programs, such as road improvements, school construction, or the expansion of law enforcement and emergency services.

When a tax deed is issued by a tax collection agency, it can be sold at auction to the highest bidder.

The buyer of the tax deed gets the ownership rights to the underlying property. This way, a tax deed can be used as an investment tool for people who want to diversify their portfolios with real estate.

For example, say you have unpaid property taxes of $6,000 for the year, but because of a job loss you have no funds to pay for it. If you become delinquent on property taxes, the county tax assessor can issue a tax deed. If you're not able to pay the past-due taxes, the assessor can move forward with a public auction of your home.

When your home is sold, the money received will be used to pay the taxes you owed, and any amount leftover would be returned to you. So if the tax deed sold for $200,000, then you would receive $194,000 ($200,000 minus the $6,000 held for taxes owed). The new owner of the tax deed could decide to flip the property, sell it to another investor, rent it out, or live in it themselves.

If you carry a mortgage on a home or another property, property taxes may be escrowed into your monthly payments.

How a Tax Deed Works

When someone purchases a home or another piece of real estate, it's with the understanding that they'll pay any property taxes assessed by the local government. After all, they are enjoying the amenities that the local government provides.

If the property owner falls behind on these tax payments, the tax assessor can issue a tax lien certificate. This tax certificate typically comes with a set redemption period in which the property owner has an opportunity to pay the taxes owed. In Broward County, Florida, for example, this redemption period lasts two years, but some states may set different time periods to redeem.

If the property owner does not redeem the property by paying what's owed, the tax collector can move ahead with a tax deed sale. This is where the property is sold at a public auction, similar to a foreclosure auction, which is held in-person or online. The highest bidder has the right to purchase the property.

If you win a bid at a tax deed sale, you may need to put down an initial deposit. The remaining purchase price is typically due within 24 to 48 hours of the auction's close, though some states may allow for more time.

If you win a bid and fail to pay the full amount due, your deposit may be forfeit and you may be barred from participating in future tax deed sales.

Once the purchase of a tax deed is finalized, ownership of the property transfers to the purchaser of the deed. This means the previous homeowner loses any rights to the property. Meanwhile, the new owner assumes responsibility for any existing liens against the property or any outstanding property taxes due.

Tax Deeds vs. Tax Liens

Tax deeds are sometimes confused with tax liens, but they are not the same. A tax lien is a court-issued order that allows a government entity a security interest in a piece of property. For example, if you fail to pay your property taxes, the local government could get a tax lien certificate to collect what you owe.

With the lien, the underlying property can't be sold or refinanced until the taxes owed are paid. If the property owner doesn't pay the taxes due, then the tax lien certificate, like a tax deed, can be sold at auction to the highest bidder. The winning bidder pays the property tax due and holds the lien against the property.

The homeowner then has to pay the lienholder back, with interest, to remove the lien from the property. Tax lien certificates can be an attractive investment for investors who want to diversify with real estate while creating passive income in the form of interest payments.

With tax lien investing, if the property owner doesn't pay back the lien, then they don't receive interest payments.

When investing in tax deeds or tax liens, it's important to perform appropriate due diligence and understand the risks involved. For example, if you're investing in tax deeds and you don’t research the property thoroughly, then you run the risk of assuming existing liens or tax debts.

Whether you can invest in tax deeds or tax liens may depend on where you live because not all states and municipalities allow such sales.

Key Takeaways

  • Tax deeds are legal documents that convey ownership interest in a piece of property.
  • A tax deed may be issued if a property owner fails to pay property taxes due.
  • Properties that have a tax deed attached are sold to the highest bidder at public auctions called tax deed sales.
  • Tax liens can also be issued against property owners with outstanding debts, but they differ from tax deeds.
  • While tax deed investing can be profitable, be sure to perform the appropriate due diligence first.