Tax Lien Foreclosure: Definition, How It Works, Vs. Tax Deed Sale

What Is a Tax Lien Foreclosure?

Tax lien foreclosure is the sale of a property resulting from the property owner's failure to pay their tax liabilities. A tax lien foreclosure occurs when the property owner has not paid the required taxes, including property taxes and federal and state income taxes.

Key Takeaways

  • If a property owner fails to pay taxes on the property, it may result in a tax lien foreclosure.
  • Government authorities address delinquent property taxes by way of tax lien foreclosures and tax deed sales.
  • In a tax deed sale, the property is sold at auction with a minimum bid of the taxes owed plus interest and any costs to sell the property.

Tax Lien investing

How a Tax Lien Foreclosure Works

A tax lien foreclosure is one of two methods a government authority may use to address delinquent taxes on the property; the other is called a tax deed sale. A statutory lien is first placed against the property of the person who has failed to pay taxes.

Tax liens can be specific liens against specific property—for example, with property taxes and special assessment liens. They can also be general liens against all property of the defaulting taxpayer, as in the case of federal or state income tax liens.

The lien is represented by a tax lien certificate, which may be sold by the state to a trust or investor through a public auction. Tax laws prevent the owner of the property (who failed to pay their taxes) from bidding at the auction. Tax lien certificates accrue interest at a set rate, making them a potentially attractive investment since they are tied to a hard asset—that is, real estate. In Arizona, for example, investors can receive up to 16% per annum on a tax lien certificate.

Redemption Period for a Tax Lien Foreclosure

In some tax lien foreclosure proceedings, the property owner may sometimes be granted a redemption period—a specific period during which the original owner has an opportunity to pay the lien and other fees. During the redemption period, which can be as short as three months or as long as three years, interest and penalties accrue to the investor holding the tax lien certificate. If and when the debt is resolved, the investor is reimbursed their investment plus accrued interest and fees on the resolution date.

The redemption period may be before—or sometimes after—a foreclosure auction has been held.

If all attempts to collect on the delinquent taxes have been exhausted and the redemption period expires, the lien holder can initiate a judicial foreclosure proceeding against the property itself. The court then orders a foreclosure auction be held to collect the money to satisfy the unpaid tax lien. The tax lien foreclosure proceedings generally result in the lien holder acquiring the property.

Tax Lien Foreclosure vs. Tax Deed Sale

Foreclosing against the property may also be done through a tax deed sale. In a tax deed sale, the property itself is sold. The sale that occurs through an auction has a minimum bid of the amount of back taxes owed, plus interest, as well as the costs associated with selling the property. Any amount bid by the winning bidder in excess of the minimum bid may or may not be remitted to the delinquent owner, depending on the jurisdiction.