A Brief Guide to Investing in Property Tax Foreclosures

When an owner of real estate doesn’t pay their property taxes, the taxing authority has the right to sue and foreclose on the property, selling it at an auction.

In the constant search for viable sources of good real estate at low prices, investors often turn to buying properties from foreclosure sales.  These sales can happen for a variety of reasons including non-payment of property taxes and non-payment of loans and other liens.

This post is focused on property tax foreclosures.

Buying properties at foreclosure sales is an attractive strategy.  Investors hope to gain instant equity at the completion of the sale by paying a price lower than the market value of the property.  However, the process can be laden with pitfalls for the uninformed.  Due diligence is critical.

As with any other investment strategy, it pays to have a clear understanding of who you are as an investor.  What is your goal? Risk appetite? Exit strategy?  We can save that for a different conversation.

Due Diligence

Due to the investor’s lack of ability to perform full-blown due diligence as in a traditional real estate transaction, risk is naturally higher in foreclosure investments.  However, the potential to hit a home run drives many investors to assume the increased risk.

Usually, an investor has advance access to a list of properties, published in various sources.  By the time the auction happens, some published properties may have been removed if the owner pays the taxes at the last minute.  Sometimes other properties are added to the auction block at the last minute.

Wise investors should avoid bidding on properties that they have not performed due diligence on.

Some recommended due diligence review items include:

  1. Running a Title Search – The purpose of this is to discover other liens or items of record, like deeds, mortgages, and judgments, affecting the property. Liens are discussed in more detail below.
  2. Examining the Condition of the Property and the Need for Repairs – Properties acquired at a tax auctions are acquired “as-is.” As such, the condition of the property should play a big role in the investor’s decision to acquire it.  Generally, an investor does not have access to the interior of a property prior to the foreclosure sale.  Owners who still reside in the property don’t take it well when investors attempt to look in their windows.  This is also trespassing.  Inspections should be limited to the exterior of the property and the appearance of the property relative to others in the neighborhood.  Investors should pay attention to big ticket items like signs of foundation, HVAC, and roof issues, the location of a property in a floodplain, and potential environmental contamination.
  3. Determining Market Value or ARVDetermining the property’s market value or after repair value (“ARV”) is important in order to avoid bidding more than the equity in the property. We advise investors not only to avoid bidding more than the equity, but to predetermine a minimum profit margin to allow for unexpected expenses, which often arise.  The anticipated equity in the property is determined by subtracting the sum of the 1) purchase price; 2) liens that survive the foreclosure; 3) necessary repairs; 4) legal fees; and 5) other expenses from the ARV.  ARV can be determined by seeking a comparative market analysis (CMA) or broker price opinion (BPO) from a qualified real estate professional.
  4. Form and Process of Initial Foreclosure Lawsuit – Investors should review the underlying foreclosure suit to ensure that the format of the suit was proper and that no procedural errors were made that would allow the former owner to overturn the foreclosure. This includes ensuring that parties in title were properly served with notice and made parties to the suit, including federal parties like the IRS, if any.

The Auction

The taxing authority will usually file its lawsuit far in advance of the foreclosure and sale in order to give the owner ample opportunity to cure the nonpayment before foreclosing.  The judgment obtained by the taxing authority will order a sheriff or constable in the precinct in which the property is located to sell the property at auction to the highest bidder.  At the completion of the sale, the sheriff or constable delivers a deed to the buyer.

Tax foreclosure auctions happen on the first Tuesday of every month, even if it falls on a holiday.  All precincts that are auctioning properties will hold their auctions simultaneously.  Investors should know when and where each of their target properties is being auctioned.  If multiple target properties are being auctioned at the same time, it can pay for an investor to have a second bidder with them.

Investors who have never bid at an auction should visit an auction at least once before bidding to become comfortable with the excitement of the process and to avoid bidding more than the pre-determined maximum bid amount.  Generally, anyone may bid at an auction.

If an investor wins an auction, he or she should be prepared to make payment immediately.  If payment is not promptly made, the constable will reopen the bidding and sell the property to a different bidder.

The best practice is to bring cashier’s checks or other certified funds in various denominations.  If exact change cannot be used, the county will issue a refund but it can take over one month in some cases.

Certified funds should be made payable to the selling constable precinct.  In the alternative, certified checks can be made payable to the buyer and then endorsed over to the selling constable precinct.

What Liens Survive the Foreclosure Sale?

If a property owner fails to pay federal (IRS) taxes, the IRS can place a lien against the owner, which automatically attaches to any properties that the owner holds in their name.  Section 26 U.S. Code § 6321 states, If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person.”

The IRS lien only attaches however, if filed of record in the county in which the property lies.  Section 26 U.S. Code § 6323(a), The lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor until notice thereof which meets the requirements of subsection (f) (Requiring notice to be filed in the real property records in which the property is locate) has been filed by the Secretary.”

If the property owner fails to pay their mortgage (if any), the lender can also attach a lien to the property.  Several other third parties have lien and foreclosure rights but those are discussed in more detail in other publications.

In most foreclosure situations, generally any first (priority) liens survive foreclosure sales and supersede the foreclosing interest.  A major benefit of purchasing properties in property tax foreclosure auctions is that property tax liens take priority over almost all other liens against the property, including judgment liens taken by unsecured creditors and even first and second mortgages and deeds of trust (if the lender is provided notice of the tax foreclosure and does nothing to protect its interest (like redeeming the property at the auction itself).

The only type of lien that that take precedence over a property tax lien and deed is a government lien, like an IRS tax lien that is filed with notice given.  IRS liens are generally treated differently than all other liens and survive most challenges, including bankruptcy.

The Owner’s Right of Redemption

 Generally, there is no right of redemption after a Texas foreclosure.  However, after foreclosure for unpaid taxes, the former owner does have a right of redemption.  If the property is homestead or agricultural property, the former owner has a two-year right of redemption from the date of filing of the tax foreclosure deed.  For non-homestead property, the redemption period is 180 days.

For homestead property, the investor is generally entitled to a redemption premium of 25% in the first year and 50% in the second year on the aggregate total of the price paid by the investor, plus certain costs dictated by Section 34.21(g)(2) of the Texas Tax Code, including property insurance and repairs or improvements required by code, ordinance, or a lease in effect on the date of sale.  On non-homestead property, the redemption premium is limited to 25%.

Allowable costs do not include a general rehab or improvement of the property.  Investors are best advised to hold the property and avoid making substantial improvements or reselling it until after any rights of redemption have expired.  Further, the law allows the former owner to request that the purchaser of the property, or the taxing unit to which property was bid off, provide that owner a written itemization of all amounts spent…”  The investor should keep a detailed record of expenses in order to avoid a dispute.

Some title companies will not insure over the redemption rights of the former owner until one year from the filing of the tax foreclosure deed for non-homestead property and two years for homestead property.  Title companies will usually assume all properties are homestead properties unless otherwise proven.  Prudent investors should do the same.

Please note that the categorization of the property as an owner’s homestead is a legal determination far beyond the filing of a homestead tax exemption with the taxing authority.  At best, a search of the appraisal district’s records for the filing of the homestead tax exemption is inconclusive.  Some owners erroneously file the homestead tax exemption on multiple properties, some do not file at all on property that is actually their homestead, and others did not own the property on January 1st of the year they are claiming for, as required in Harris County.

If the taxing authority tears down the property during the tax suit (a practice that happens commonly in some cities), the vacant lot does not necessarily lose its homestead status.

What to do After the Foreclosure Sale

 This is the awkward part.

 Per the Texas Tax Code, “The right of redemption does not grant or reserve in the former owner of the real property the right to the use or possession of the property, or to receive rents, income, or other benefits from the property while the right of redemption exists.”

 The foreclosure sale gives the new owner title to the property, subject to the former owner’s right of redemption and their possession of the property if the former owner does not vacate the property after title transfers to the investor.

The best practice is for the investor to contact the former owner and discuss their options.

  1. The former owner can immediately exercise their right of redemption by paying to the investor the amounts noted above;
  2. The former owner can contractually waive their right to redemption (in writing), usually in exchange for some payment from the investor;
  3. The former owner can lease the property from the investor subject to the terms of a written lease, usually containing special redemption and reimbursement language; or
  4. The investor can try to gain possession of the property by evicting the former owner by filing a forcible entry and detainer suit, which will not be discussed in detail here. The cost of the eviction should be built into the investor’s budget from the outset.

Conclusion

While purchasing investment properties from property tax foreclosure auctions can be a lucrative proposition, it requires investors to fully evaluate and understand their risks from the outset.  Proper due diligence and contract documentation are critical to the success of the business model and for the avoidance of hidden traps.

2 thoughts on “A Brief Guide to Investing in Property Tax Foreclosures”

  1. You actually make it seem so easy with your presentation but I find this topic to be actually something that I think I would never understand. It seems too complicated and extremely broad for me. I’m looking forward for your next post, I’ll try to get the hang of it!

  2. This was a wonderful informative post you publish on this page for the guide of removing property tax following all the awesome guidelines mentioned in the great passage especially “FILE THE PROTEST.” Thanks!

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