All states have laws allowing local governments to recover delinquent property taxes by seizing and selling the tax-encumbered property. While the specific procedures used for this purpose vary considerably from state to state, most states fall into one of two broad categories: tax lien states or tax deed states.
In tax lien states, the government imposes a lien on the tax-encumbered property in the amount of the delinquent taxes, plus whatever interest, fees, and penalties may apply. This lien gives the government a legal interest in the property, but actual ownership and possession of the property do not change unless the lien remains unpaid when the redemption period ends.
Typically, the government will sell this lien at auction either to the highest bidder or to the bidder who agrees to charge the property owner the lowest interest rate on the lien. The winning bidder becomes the tax lien holder.
Through this process, the government is able to recover the tax debt from the tax lien holder, who in turn is entitled to seek payment (including interest) directly from the delinquent taxpayer. If the taxpayer fails to pay off the lien (plus interest, fees, and penalties) within a certain period, the tax lien holder may then foreclose on the lien and take full title and possession of the property.
In tax deed states, too, the government generally imposes a lien on tax-encumbered property. The difference is that the government does not sell the lien. Instead, the government holds the lien either until it is paid off or until the time limit for discharging the lien runs out.
If the lien remains unpaid when the time limit runs out, the government may take ownership of the property. Once it takes ownership, the government will usually sell the property at auction to the highest bidder to recover the unpaid taxes.
In short, the key distinction between a tax lien state and a tax deed state is whether the government sells a tax lien for someone else to enforce and foreclose or keeps the lien to enforce and foreclose itself.
The key distinction between a tax lien state and a tax deed state is whether the government sells a tax lien for someone else to enforce and foreclose or keeps the lien to enforce and foreclose itself.
Tax Lien States vs. Tax Deed States: The Property Owner’s Perspective
Regardless of how state law handles unpaid property taxes, the property owner has an inherent right to the surplus equity—the property’s market value minus its indebtedness. Without an explicit requirement that the property be sold fairly and the surplus proceeds be returned to the former owner, neither the tax lien nor the tax deed procedure protects that right.
Consider the examples of Geraldine Tyler in Minnesota (a tax deed state) and Lynette Johnson in New Jersey (a tax lien state). Neither state affirmatively protects the former owner’s equity interest in tax-foreclosed property.
In Minnesota, Hennepin County imposed a lien on Geraldine’s condo for unpaid taxes in the amount of $15,000. When the lien remained unpaid at the end of the redemption period, the county automatically foreclosed, and the state took title to Geraldine’s condo in trust for Hennepin County.
The county next held a public meeting to determine whether to keep the property, transfer it to another government entity, or sell it to a private party. In this case, the county sold the property to a private party for $40,000 and pocketed all the funds. Geraldine lost everything: $78,000 in equity.
In New Jersey, the city of East Orange imposed a lien amounting to nearly $20,000 on Lynette’s commercial property. Because New Jersey is a tax lien state, the city was required to sell the lien at auction. However, no one bid on the tax lien, so by operation of law, the city “purchased” the tax lien it already held.
After the redemption period expired, the city instituted judicial foreclosure proceedings, which eventually gave East Orange full title to the property. The city later sold the property to a private investor for $101,000 and kept all the proceeds. Just like Geraldine, Lynette lost everything: $81,000 in equity.
What if a private investor had purchased the tax lien on Lynette’s property? If that had happened, the investor—not the city—would have instituted the foreclosure. Lynette still would have lost everything.
From the perspective of a property owner struggling to keep up with tax payments, there’s no difference between living in a tax deed state and living in a tax lien state.
Tax Lien States vs. Tax Deed States: Government and Investor Perspectives
The distinction matters more for governments and investors than for the victims of tax-and-take laws.
In tax lien states where the lien is sold by “bid-down” procedure—that is, where the lien’s purchase price is fixed at the amount of the tax debt—investors typically get a sweetheart deal. They purchase the lien for cheap, eventually foreclose, and get the whole property for a song.
In a tax deed state, the government sells a deed to the property itself. This deed is more valuable than a tax lien and more likely (but by no means guaranteed) to generate a sale price that more closely reflects the property’s market value. Because investors will typically pay much more for a tax deed, the government reaps the windfall.
But even this difference will not always play out. For example, the tax deed to Geraldine Tyler’s condo sold for $40,000, but the property’s value was closer to $93,000. Subtracting the $15,000 tax debt, Geraldine’s equity interest was worth $78,000. The government and the investors split the difference, so to speak, with $40,000 paid to the government and the remaining $38,000 kept by the investor.
Although each state has different procedures, and the national landscape of tax foreclosure laws is correspondingly complex, none of this complexity makes a difference to a tax-and-take victim. All that matters is whether the former owner’s equity interest in tax-foreclosed property is protected or not.