Tax Lien Foreclosure: What They Are & How They Work

Tax lien foreclosures are properties that have been repossessed by government agencies due to outstanding tax debt owed by a homeowner. A tax lien is essentially a debt owed on unpaid property taxes, income tax debt or other local, state or federal taxes that go unpaid, but tax liens are most commonly associated with unpaid federal taxes.

What Is A Tax Lien?

Tax liens are a debt obligation or claim the city, town, municipality, or government makes on a property when the owner fails to pay their annual property taxes.

Property taxes are calculated locally in the US using a ‘total tax rate.’ The total tax rate for each property is a number – which includes all public expenses covered by taxpayers in that area – multiplied by a property’s assessed value. That way, more valuable properties pay a higher percentage in property taxes.

Property taxes are levied together from school districts, counties, and cities. Property taxes are always tied to the total value of the property as a percentage.

Property taxes fund public projects and expenses like garbage collection, roads, schools, and police.

In the US, the average homeowner pays just over $2,500 in property taxes. Tax rates vary by state. In 2022, the states with the highest property taxes were Vermont, Connecticut, Illinois, and New Jersey, with rates ranging from 1.43% to 1.79% of the total property value. Hawaii, Alabama, and Arizona had the lowest rates, averaging 0.30%.

How Do Tax Lien Foreclosures Work?

When a homeowner fails to pay their federal taxes, the Internal Revenue Service will issue a Notice of Federal Tax Lien, which outlines the amount owed in taxes to the government, plus additional fees and associated costs. If the tax debtor does not pay off their debt owed within the time frame specified by law, the IRS will issue a Notice of Federal Tax Lien.

This essentially means that the government has the legal right to impose a lien on a tax debtor’s property, giving them the legal basis for eventually repossess the property and sell at tax lien auction if the tax debt goes unpaid. The proceeds of the auction are then used to cover the debt owed.

Tax lien foreclosures are very common and for buyers they can present some fantastic opportunities to buy properties below market value. The procedure by which these tax lien foreclosures are sold off can vary from the federal, state and county level.

As the taxing agency of the federal government, the Internal Revenue Service has complete power to record a tax lien against real and personal property owned by delinquent taxpayers as security based on income taxes owed.

A Notice of Federal Tax Lien will be filed against the taxpayer’s property only after the IRS assesses the liability, sends out a Notice and Demand for Payment, and the taxpayer neglects or refuses to pay the full amount within 10 days of notification.

Local Laws and Regulation Vary

Depending on the individual county, tax foreclosure auctions can be called anything from “Property Tax Foreclosure Sales” or to “Property Tax Foreclosure Auctions.” In the end, they all mean the same thing.

Different local governments can call them by different names, but the process is basically the same, and so is the result: a home that was foreclosed on for delinquent property taxes is being sold.

Information on tax foreclosure sales is readily available in many counties through their websites including when the auctions are held and the procedures to follow in order to bid on those properties

Tax Lien Foreclosure Vs. Tax Deed Sale

Tax liens and tax deed sales are the two main ways a municipality can have a legal claim against the assets of individuals or businesses that fail to pay property taxes.

To generate lost revenue from unpaid taxes, municipalities, and local governments offer investors the option to invest in tax liens and tax deeds by paying off the homeowner’s outstanding debt.

However, it’s important to note that tax lien and tax deeds differ.

A tax lien is a claim the government makes on a property – and investors who choose to invest in this type of lien are purchasing the right to collect interests on the unpaid property taxes and place a lien on the property.

Basically, investors purchase the right to act as a tax authority and collect all property tax payments from that property. Depending on the location, interest rates on property taxes range from 2%-36%.

Illinois is the most attractive state, with penalty interests going as high as 36%. The rate is between 16% and 18% in Florida and Arizona.

If the owner pays out the outstanding balance on the tax lien within the stipulated period – if you’re in Texas, that’d be in January every year –the investor who purchased the tax lien gets back their initial investment plus any interest earned along the way.

If the owner doesn’t pay the outstanding tax balance, the property goes into a tax deed auction. After the tax deed is sold at auction, property ownership is transferred to the buyer of the tax deed.

Financing Flexibility

If you’re looking to finance a foreclosed home purchase, the Department of Housing and Urban Development (HUD) offers excellent options for first-time homebuyers:

• 203(k) Rehab Mortgage Insurance (Federal Housing Administration & HUD)
• HomePath ReadyBuyer program (Fannie Mae)
• The HomeSteps program (Freddie Mac Homes)

Real estate inventors don’t qualify for these financing options – only first-time home buyers who intend to use them as their primary residence. Here’s what each of these programs offers:

• The 203(k) Rehab Mortgage Insurance can be used to purchase or rehabilitate a home. You can apply through an FHA-approved lender. 
• The HomePath ReadyBuyer program offers 3% of the purchase price in cost assistance for first-time homebuyers. This applies to the purchase of a HomePath property.
• The HomeSteps program offers housebuyers – not necessarily first-time homebuyers – the option to purchase HomeSteps homes without competition from real estate investors.

What Happens If You Don’t Pay Property Taxes?

If you don’t pay your property taxes on time, the taxing authority may sell your property through tax foreclosure or a tax deed to pay off any outstanding debt.

Property taxes are calculated based on a property’s assessed value, your tax filings from the previous year, and the average local tax rate in your county.

This doesn’t happen overnight – in general, you have until the end of January every year to pay off your property taxes. Before you pay them off, any outstanding debt will become a lien on the property.

How Do You Remove A Lien From Your Property?

If the lien on your property is accurate, the easiest way to remove it is to pay it off. After you pay it off, fill out a release-of-lien form – a clerk at your closest county office can provide one for you. The lien holder must also sign the form before a notary. Alternatively, you can hire a local attorney to take care of it.

If the lien on your property isn’t accurate, you’ll need to contact your lawyer. You can also contact the creditor or lien holder to provide proof of your debt.