Tax Sales, Tax Certificates, Tax Deeds: Due Diligence Matters!

We have all heard the ‘infomercial’ and the Internet claims regarding tax foreclosed property:

• “You will own the property FREE and CLEAR!”

• “All other liens and interests are WIPED OUT!”

• “You will hold the FIRST PRIORITY security interest!”

• “The Government GUARANTEES these properties!”

• “All liens, interests, and encumbrances are ERASED!”

• “You can do this part-time with nothing down!”

• “You don’t need to set up a company…just get out there and make a deal!”

While this can make great marketing material it is not in accord with the reality of tax foreclosure purchases. As an attorney, I learned in law school that every rule of law has an exception. Knowing how these exceptions work will mean the difference between success and failure as a real estate investor on the grandest of scales! I don’t make that statement lightly, rather I make it with as much of the emphasis and weight that the English language will allow. Please read it again, “Knowing how these exceptions work will mean the difference between success and failure as a real estate investor on the grandest of scales!”

If you intend to be successful you must be able to separate marketing fluff from well researched and analyzed fact. If you rely on marketing materials and hype your failure is nearly certain, however if you rely on well researched information formulated into a methodology then the keys to success in any endeavor are in your hands.

What Does This Mean to Me and Why Should I Care?

What this means is that you must forget about blanket marketing statements when dealing with tax foreclosed property. For every statement that is contained in the bulleted list (at the top of the page) there is an exception and just like any business what you don’t know WILL hurt you. If you have contacted me by email or purchased one of my courses you know that I absolutely believe in covering all the positive and negative aspects of investment techniques. This does not mean focusing ONLY on the benefits or making wild claims about investment techniques. It DOES mean thoroughly covering what could go wrong and a relentless approach to risk reduction.


In the following sections we will review some of the areas that you must consider when researching and evaluating tax sale properties. I call them due diligence areas #1 through #5. These are not an exhaustive list but they do set out some of the areas which are typically left out of most people’s analysis. For a complete list please review my course materials.

Due Diligence Area # 1:
What Liens Will Survive Foreclosure?

One area that really upsets me is when I hear a general rule of law blindly applied to every tax foreclosure situation with reckless abandon. Whenever you hear that the foreclosure of a tax lien ‘wipes out all over liens’ or that the property is now ‘free and clear of all other liens’ a general rule has been overstated. The general rule can be found in the property code of every state and the UCC (Uniform Commercial Code) which covers commercial transactions. The general rule can be stated as: The foreclosure of the superior lien will eliminate the rights of any junior interests in the realty or personal property. This general legal rule stands for the proposition that: that when a superior lien (one that was recorded or ‘perfected’ before all others) is foreclosed (i.e., through the state’s legal foreclosure guidelines) any junior interests will lose their interest in the property. Remember that there are exceptions to this general rule.

Let me give you an idea of some of these exceptions:

1) Federal Tax Liens – Since most liens on a property will likely be liens from the state or a municipality within the state you must be aware of the possibility of a federal tax lien. You can ask your title company to search for this, however a good title company should spot this lien pretty quickly.


2) State Income Tax Liens – Some states which have a state income tax may give priority to any liens for unpaid state income taxes. As the purchaser of the property or the holder of the lien you could still have these liens surviving as encumbrances on your property even after foreclosure.


3) State Sales Tax Liens – Unpaid state sales taxes can result on a lien which attaches to the property of the delinquent taxpayer. You should contact an attorney to find out if your investment state has a sales tax lien which could survive foreclosure.


4) Mechanics Liens and Materialmen’s Liens – Work performed on the property where improvements or repairs are made can result in a mechanics lien if payment is not made by the party who contracted for these services. You will find many different names for this type of lien, for example: mechanics liens, materialmen’s liens, artisans liens, workers liens, etc.


Don’t forget to learn more about your investment state as your state could include others or exclude some of these liens. Don’t be scared off by this list, BUT glad that you are now informed about this potential risk. Since you have the knowledge you need only perform adequate research to avoid the risks in this area.

Due Diligence Area # 2:
Are Environmental Risks Associated with the Property?

In some instances you can run the risk of purchasing someone else’s environmental liability. Congress passed the ‘Superfund Act’ (42 U.S.C. 9601 et seq.) which made every landowner liable for previous environmental contamination on a property regardless of whether they caused the damage or not. There is some good news for lienholders since Congress has given them an exception from liability if you are a lienholder not considered an ‘owner or operator’. Court rules and interpretations have been changing regarding this issue so don’t risk it. I want to be sure my liability is limited therefore I believe in being extra cautious when dealing with commercial properties in the tax sale setting. If there is some question as to the area or type of business conducted on the parcel you should contact an environmental specialist and ask some preliminary questions about the area and property you are investigating.


If you want to steer clear of the whole issue then you should avoid commercial properties all together. The chances of environmental damage found on residential properties in zoned subdivisions is much less. I do tell my students to avoid commercial properties unless it’s a really good deal. Naturally if it is a good deal you can afford to do the extra research to make sure there are no environmental problems on the property.

Due Diligence Area # 3:
What About Other Fees Not Included in the Foreclosure?

You should always get an idea of whether there are any other fees or dues not included in the foreclosure purchase price. I know this sounds odd but it can occur if an entity that is owed money was not included in the tax foreclosure lawsuit. If they did not get notice or did not decide to ‘join’ themselves in the collection lawsuit then the money simply won’t be added to the opening bid amount. The purchaser of the property would still be responsible to pay for these fee amounts.


Here is what I suggest that you do:


Contact the tax collection entity or authority (typically the tax Assessor)
Ask them which entities they collect taxes for
Then ask which entities are outside of their collection area
Create a list of entities whose taxes are not collected by the Assessor BUT may still be owed by delinquent taxpayer
Call and ask the entity the amount of back taxes, dues or fees
Add this amount to your bid analysis



Again, by following a simple step-by-step methodology you can greatly reduce you risk and boost your success rate ten fold. Make sure you go through this checklist of tasks with every property you consider purchasing.

Due Diligence Area # 4:
Bankruptcy of Delinquent Property Owner

You must check to see if there is a looming bankruptcy Associated with the property. I see very few tax sale products covering this issue. This is an ABSOLUTE MUST in your analysis of any property. You can access federal bankruptcy records through the federal bankruptcy court in your state. Some of these records may be online. There are generally two main possibilities that you must be wary of:

1) A Bankruptcy has occurred prior to purchase – Sometimes you will find that a property is tied up in a bankruptcy administration while it is being prepared for tax sale. You should avoid properties which are on a tax sale list which have a pending bankruptcy suit.

2) A Bankruptcy has occurred during the redemption period - This scenario can be problematic as well. Here the property has been sold to tax sale investor but while the redemption clock is ticking the delinquent property owner has declared bankruptcy. Now a trustee has been appointed to protect the assets of the estate. The biggest risk to the tax sale purchaser is that the trustee will attempt to argue that the tax sale purchase was a ‘fraudulent transfer’. For such an activity to occur there must at least some dealing or scheme between the debtor and the purchaser such that an attempt is made to avoid liquidation of the estate by transferring property to a 3rd party. While the tax sale purchase really should not be classified as such a transfer if the trustee raises this argument it can interfere with the tolling of redemption period, your ownership rights and the final disposition of the tax sale property or lien. Keep in mind that if the trustee wins this argument you won’t lose your initial investment, but you will lose any of the anticipated profit. It is not an easy argument for the trustee to win but just be wary of this possibility.


The best thing to do is to avoid situations where you know the property is involved or will be involved in a bankruptcy. You should check in the owner’s district of residence for any bankruptcy filings. Lastly, don’t be too frightened by this issue because doing your research will help you greatly reduce your risk of being affected by a bankrupt estate.

Due Diligence Area # 5:
Doing Deals in Your Own Name

This is an area that is very critical to apply and apply correctly. If I could refuse to sell my products to someone who does not have a legal business entity from which they will make these purchases, I would do it. That means that if I find out you are buying tax sale property in your own name I will come and take my course from you! No seriously…this is a very critical issue and I just want you to understand how much it worries and keeps me up at night knowing that some of you will ignore my advice and buy tax deeds as ‘John Jones’ instead of ‘Jones Real Estate, Corp.’
Why is this such a bid deal? The reason is that when you purchase a property as an individual you are now personally liable for the anything that goes wrong with the property. This could include someone getting hurt on the property (yes, even a trespasser can sue you), environmental issues with the property, liability from ‘unknown’ liens, and a myriad of other problematic scenarios.


However, when you form an entity you generally will not be personally liable for these acts, omissions, or hidden liabilities. What will happen is that the corporation, partnership, or LLC will take the hit. Now why did I say that ‘generally’ you will not be liable? I said that because if you do not maintain the entity using the proper formalities you will lose that protection. In a landmark business law case the courts determined that to “preserve equity and prevent injustice” it could “pierce the corporate veil” and hold the shareholders or owner(s) liable for the acts and/or omissions of the corporation if proper formalities were not met.


If you go to any real estate investing seminar and they tell you, “Just do a deal or two then worry about forming your company”, please run out the door! It will only take one bad deal to make you liable thereby risking everything you own. Before you attempt a deal you should find an attorney to help you determine which form of business entity will serve you:

Corporation – C-corp or S-corp.; or
Limited Partnership (LP); or
Limited Liability Limited Partnership (LLLP); or
Limited Liability Partnership (LLP); or
Limited Liability Company (LLC)

You should then have the entity up for you and teach you how to maintain its formal status in the eyes of the law. I have helped individuals with the matter and I can tell you that you must have an attorney who will listen to your needs and spend time educating you. The reason I think education is important is that if you don’t maintain the entity correctly its the protective shield will not exist in the eyes of the law. It will be as if you never incorporated at all. What good will the slick corporate minute book and fancy company logo be if the attorney did not teach you how to keep the entity separate from your personal dealings? Unless your attorney takes the time to teach you how to maintain your entity status it will be worthless.


I want to wish you the best of luck in your endeavors and email me at taxenterprises@yahoo.com if you ever need help!