Tax Sale Bidding Methods

Tax sales are done through a public auction process.  The reason for this is to establish that the delinquent property owner will get the fairest treatment possible.  Each of the states have passed their own method of doing this and it ends up that there are several different bidding methods that have evolved over the years.  We will discuss the various methods in this article.

Tax deed sales (where you end up owning the property after the sale) all use the same basic method.  They sell the property to the person giving the "highest and best" bid, or, in other words, to the person willing to pay the most for the property. 

The only real difference in the bidding systems for tax deed sales is the starting level for the bid.  In some jurisdictions the minimum bid is some percentage of either appraised value or market value.  In other jurisdictions it is the taxes, interest, and penalties owed.

Where you find a major difference in bidding systems is in Tax Lien sales. There are several different systems used for tax lien sales.

Round Robin bidding:  This is a very simple system, they go around the room in seating order and ask if you want to buy the lien.  If you pass on it, the next person has the opportunity to buy it or pass on it.

The benefit of this system is that everybody gets an equal chance to buy a lien.  The disadvantage is you don't get the chance to pick which lien you get offered.  You can only say yes or no to what is offered.

Lottery System bidding:  This is a high tech version of round robin bidding.  Here the jurisdiction has a computer program that uses what is known as a random number generator to pick the person who gets the chance to buy the lien.   Each bidder has a bidder number and all the numbers are entered into the computer.  The computer operator pushes a button and the computer picks a bidder number.

The benefits and disadvantages of this system are the same as round robin bidding with one small difference.  Luck also enters into this bidding.  In theory every person should be picked the same number of times but the reality is some people will be called on more than other people.

Highest and Best Bid:  In this system they sell the lien to the person willing to pay the most money for the lien.  There are several different variations to the system.  The issue is what happens with the amount you bid above the taxes owed, which is called the overbid or premium.

1.       Interest on the premium:  In this variation you earn interest on the total amount of your bid.  So if the minimum bid for the lien is $2,000 and the highest bid is $20,000, you earn interest on the whole bid of $20,000.  This system does favor those with more money to invest and is one that is favored by institutional bidders, who will often bid as much as 50% to 70% of market value of the property to buy the lien.  Upon redemption you get the premium back

2.       No interest on the premium:  This system pays you interest on the taxes owed but no interest on the premium or overbid.  The effect is that any premium you bid reduces the effective interest rate you earn on the lien.  Upon redemption you get the premium back.

3.       No interest on the premium and you don't get the premium back:  This system is only used in Colorado and Mississippi and is the only system where you can buy a tax lien, have it redeem, and still have the possibility of losing money.  In these two states you do not get the amount you bid in overbid or premium back.  Therefore it is possible that the interest you earn is less than  premium you bid, which would result in a loss.

4.       Interest on the premium but a cap on how much interest you can earn:  This is the South Carolina system.  They sell the lien to the highest bidder and you do earn interest on your total bid, but the total amount of interest you can earn cannot exceed the dollar amount of the minimum bid.   For example:  If the lien is $2,000 you could bid $60,000 to buy the lien, but you would not make more than $2,000 in total interest on your bid. Upon redemption you get the premium back.

Percentage of Ownership Bid:  In my opinion this is a very flawed system but is, unfortunately, used in several states.  The lien is sold to the individual who is willing to take the smallest percentage of ownership in the property, if, and only if, the lien does not redeem.

The flaw in the system only occurs if there is no redemption to the lien.  In that case, the lien buyer becomes a tenant in common with the delinquent property owner and has to ask the court to partition the property to get their money out.  This is an expensive process and if you have a small percentage of ownership, for example, less than 25%, the costs could be prohibitive.

Further evidence that this is a flawed system is that although it is the state law in several states, a number of jurisdictions in those states have devised ways to do lottery sales or round robin bidding instead of percentage of ownership bidding.

Bid Down the Interest Rate:  This system is used in several states and is often misunderstood by those new to tax sales.   For example, IL, NJ, FL and AZ use variations of this system.  Often these states are touted as 18% or 16% states, whereas the reality is that is where the bidding starts.  The lien is sold to the individual who is willing to accept the lowest interest rate.  Often times that will turn out to be 5% to 8% rather than 16% to 18%.