By Robert M. Steeg
For investors, depending upon your point of view, tax sales are a) a cheap way to acquire good real estate, b) a good way to get an above-market yield on your cash, or c) something to stay away from.
Generally speaking, most people are not aware of the pitfalls and risks. Below is a rudimentary explanation of how the tax sale process works. After reading what is really involved, you can decide which of the above alternatives that you choose.
Every Property Owner Owes Real Estate Taxes
We start with the proposition that every property owner owes real estate taxes to the parish tax collector. Taxes in Orleans Parish are payable in advance at the beginning of each year. Taxes in all other parishes are payable in arrears at the end of each year. There is a due date for payment of the taxes, after which the taxes become delinquent. Once the taxes are delinquent, interest and penalties start to accrue. The amount of the taxes, interest, and penalties are all added together into one collective amount that the taxpayer owes.
For purposes of this article, let’s call that the “Tax Amount.”
What is a Tax Sale?
If the Tax Amount is not paid within 20 days after the tax collector sends the notice, the tax collector has a special mechanism by which it can collect the Tax Amount. It can begin a process that will ultimately result in someone else (“Tax Purchaser”) paying the tax collector the full Tax Amount, and the Tax Purchaser then has a series of rights that can lead to the Tax Purchaser becoming the owner of the real estate. That process is generally known as a “tax sale.”
The Tax Sale Process: It’s Complicated
At the beginning of this process, soon after the delinquency date has passed, the tax collector must give notice of the delinquency to the property owner and all other persons who have a recorded interest in the property, telling them that the Tax Amount is delinquent and that, if it isn’t paid in full, the property will be offered for sale at a tax sale for the unpaid charges.
This process of notification is in itself a complex and critical step, because anyone with a property interest is entitled under the federal and state constitutions to “due process of law,” and that includes notice before a person is deprived of a property interest. So, not only must the property owner be given notice, but this requirement extends to any person with a recorded mortgage or judgment or lien, and further to any person with a recorded lease or servitude.
In this article, let’s call those persons the “Notice Parties.”
These same considerations apply to each notice that must be given throughout the tax sale process described here.
Correct addresses for all of the Notice Persons are not always known to the tax collector, so there is always a question as to whether the written notice of the tax sale was received by each person entitled to receive it. If it was not received, then “due process” requires the tax collector to engage in reasonable steps to ascertain the person’s address and to engage in reasonable efforts to try to achieve actual receipt of the notice. Of course, a constitutional issue such as this is always open to interpretation and challenge.
A Bidding Process Determines the Winner
Tax sales are held at least once per year. They are tracked on a web site called CivicSource.com.
Once a tax sale is scheduled and the properties are identified, notices must go out to all the Notice Parties, specifically informing them that the property is about to be offered for sale for the Tax Amount.
At the tax sale, there is a “bidding” process to determine who is the winning tax sale certificate purchaser for each property. However, it is not money that is the subject of the bidding. Since the property may ultimately be taken away from the current owner, the process has been structured so that the bidders declare what percentage interest in the property they are willing to take away from the current owner. The winning bidder is the one who takes away the least, leaving the current owner still owning part of his property.
For example, let’s assume that the property at 123 Spruce Street is a single-family home worth $200,000.00. It is in poor condition, because the owner can afford neither the repair costs nor the property taxes. Several people are interested in the property because they see potential to renovate it and sell it at a profit.
Tax Purchaser A wants to own the entire property, so at the tax sale he is going to “bid” that he will take a 100% interest in the property. Tax Purchaser B is willing to acquire less than 100% full ownership, but is not willing to own less than a majority interest, so he bids 51%. Tax Purchaser C is more of a risk-taker. Not knowing what the other buyers are willing to bid, he bids a 25% interest in the property. If no one bids lower, Tax Purchaser C will be the winning bidder. He is essentially saying that if he comes to own the property, he will own 25% of it, and the property owner who failed to pay the taxes in the first place will continue to own a 75% interest in the property.
Many times the bidding gets down to the smallest possible percentage. The smallest percentage that can be bid is 1%. The first one to bid 1% is the winner.
The Winner Pays in Full in Exchange for a Tax Sale Certificate Title
The successful tax bidder must pay the tax collector the Tax Amount in full. In exchange for that payment, he or she receives a “tax sale certificate title,” evidencing that he or she was the successful bidder and identifying the percentage that he or she bid. He or she does not own the property. He or she has the legal right to go through a process at the end of which he or she may become the owner of the percentage of the property he or she bid.
In addition, after the tax sale, the Tax Purchaser must provide an additional written notice, to all of the Notice Parties, of the fact that the property has been sold to him or her at the tax sale.
Tax Sales are “As Is, Where Is” Affairs
Tax sales are “as is, where is” affairs. They cannot be rescinded later on account of any problems that the Tax Purchaser might discover. This means that if the Tax Purchaser wants to determine whether he or she will be getting good title to the property, he or she must perform a public records search before the tax sale to determine the status of the title to the property. Similarly, the Tax Purchaser is taking a chance on the physical condition of the property, because he or she has not had a chance to do a physical inspection. It is not owned by the tax collector, so the tax collector does not have the right to let any prospective bidder go into the property and inspect it.
The Owner Can Redeem the Property for Three Years
The owner of the property has an absolute right, for three years after the tax sale certificate is recorded, to “redeem” the property (i.e. to recover full ownership of the property) and eliminate the rights of the Tax Purchaser. To do so, the property owner must pay to the Tax Purchaser 1) the full Tax Amount, 2) 1% per month on the Tax Amount, and 3) an additional penalty of 5% of the Tax Amount.
Tax Purchaser Must Bring “Quiet Title” Lawsuit to Establish Rights
After the three-year period has elapsed, the Tax Purchaser must bring a “quiet title” lawsuit in order to establish the validity of his or her rights in the property. The property owner and all other Notice Parties must be brought into this lawsuit. It is at this stage that the property owner and any other Notice Party can challenge the adequacy of all of the notices that were provided with respect to the tax sale. If the property owner or another Notice Party can prove that he or she did not receive notice, he or she can challenge the validity of the tax sale.
If a Notice Party succeeds in arguing that he or she was denied “due process of law” or that any of the various state statutes governing tax sales were not complied with, that Notice Party can annul the entire tax sale process. The rights of the Tax Purchaser are negated and the Tax Purchaser is entitled to recover only the original Tax Amount paid at the tax sale, and he or she does not receive the 1% per month interest or the 5% penalty – although there is one recent case allowing a greater recovery, so this particular point is not fully settled.
So, at a minimum, the process takes in excess of three years. During that time, real estate taxes continue to be assessed and charged by the tax collector. The original Tax Purchaser must pay those taxes in order to avoid the property being offered at a subsequent tax sale for those later years’ taxes, which will have priority over his or her tax sale acquisition. The Tax Purchaser continues to be entitled to receive 1% per month interest and the 5% penalty on the amounts expended by the Tax Purchaser for subsequent years’ taxes.
Tax Purchaser Case Study
Now let’s return to the Tax Purchaser who successfully bid a 25% interest in the property at 123 Spruce Street. He or she has waited for the three-year mandatory redemption period, and no redemption has occurred. He or she has brought a quiet title lawsuit, and was successful. He or she now owns a 25% undivided interest in 123 Spruce Street. The original property owner still owns the other 75%. They are co-owners.
The two of them are now subject to the underlying laws of Louisiana concerning co-ownership. Either one of them is entitled to bring a lawsuit for what is called a “partition” of the property, the end-result of which will be that the co-owners become separated and no longer joined together as co-owners. If the property can be physically divided without harm to its value, then the property would be physically divided on a 75/25 basis. However, the property at 123 Spruce Street is a single residential structure, so it cannot be divided in this manner. Therefore the result of the partition lawsuit will be to put the property up for sale at a judicial auction, where it will be awarded to the highest bidder, and the sale proceeds (minus court costs and commission to the governmental department that conducts the auction) will be divided on a 75/25 basis.
If 123 Spruce Street has increased in value, a third party might be the successful bidder, in which case our Tax Purchaser receives 25% of the net sale proceeds. Or, our Tax Purchaser might be the successful bidder, in which case the original property owner receives 75% of the net sale proceeds. In either event, because of the nature of the judicial auction process, additional bidders will learn of the property’s availability, and the auction price is likely to approach some measure of “fair market value,” and if the Tax Purchaser wants to own the property, he or she will have to bid the highest amount of cold, hard cash at the partition sale auction.
Tax Sales – Risks Versus Rewards
This is a thumbnail sketch of the process. It involves a minimum of two lawsuits and, realistically, 4 or more years to acquire title to the real estate. Most tax purchasers are not aware of the pitfalls and risks.
There are obviously far less complicated ways to acquire real estate. If one hopes to use the tax sale process to acquire only a single piece of property, then all of the risks described above can turn that single investment into a costly mess. For that reason, savvy tax purchasers try to spread their risk across multiple properties, on the theory that they might end up being able to acquire title to one or two properties among the group, knowing that the odds are against successfully acquiring title to any particular parcel.
These same savvy investors comfort themselves by reasoning that, with respect to the properties they do not acquire, they have a good chance of earning 1% per month interest plus a penalty of 5%. Of course, as we have seen, it does not always work out that way. So, again, these investors try to spread their risk across a large group of properties, knowing that any individual property could be a loser.
Still other investors avoid the process entirely, because of all the complications discussed above.
What’s your choice? Hopefully, after reading about the process, your decision will be a little better-informed, whatever it turns out to be.