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Updated almost 4 years ago on . Most recent reply

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Denise Evans#3 Tax Liens & Mortgage Notes Contributor
  • JD, CCIM , Real Estate Broker
  • Tuscaloosa, AL
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Alabama Tax Sales Auction, Excess Bid, and Redemption

Denise Evans#3 Tax Liens & Mortgage Notes Contributor
  • JD, CCIM , Real Estate Broker
  • Tuscaloosa, AL
Posted

This article is for tax sale investors who want to earn redemption interest income. Investors who want the real estate should read this, also, because sometimes their plans go astray and an owner redeems.

In Alabama, someone who wishes to redeem their property from a tax sale must pay 12% per year interest on the taxes due at time of sale plus all subsequent years' taxes and interest.  If there is a bidding war at the auction, then the highest bid will be greater than the tax bill. The surplus is called the "excess bid." The excess bid money is held by the county for 10 years. Under current law, if someone redeems, then the excess funds are repaid to the investor. If nobody redeems, the excess funds are eventually forfeited and go to the county.

A redeeming owner pays the taxes plus interest, and also pays interest on the excess bid, but only on a portion. The rule is, the owner pays 12% per year interest on the taxes, and also on that portion of the excess bid that is equal to or less than 15% of the tax assessor's value placed on the property. The remainder of the excess bid earns no interest.

An example helps explain this.  Suppose the tax assessor (or revenue commissioner, depending on the county) places a value of $100,000 on a property. It must do this for all properties within the county because the taxes are based on the value.  Suppose the taxes due for the current year are $500, and remain unpaid at the time of the annual auction.  The auction starts at $500, but you and another investor quickly bid the price up to $20,000.  You win the bid.  You pay $20,000 to the probate judge and collect  your tax certificate.  Of the $20,000, only $500 is for taxes, and the remaining $19,500 is excess bid.

Exactly one year later, the owner redeems.  We are going to ignore things like preservation improvements and insurance premiums for the purposes of this post.  I will write about those, later. 

Here is the redemption price tag:

  • $500 taxes due at time of auction, plus 12% interest ($60 interest)
  • Current year's taxes, paid directly to the tax collector
  • 12% (per year) interest on only $15,000 of the $19,500 excess bid ($1,800 interest)  $15,000 is 15% of the tax appraised value of $100,000
  • 0% interest on the remaining $4,500 of the excess bid.

The owner will pay a total of $500 for the past due taxes that caused the auction, plus $1,860 in interest.  You will receive your entire $20,000 back ($500 paid by the owner at time of redemption, plus the $19,500 being held by the county) plus $1,860 in interest.

Because some of the excess bid did not earn any interest at all, it "drags down" what we call the "Effective Interest Rate."  If you earn $1,860 per year on an investment of $20,000, then the REAL interest rate is only 1,860 divided by 20,000, or 9.3% interest.  Your Effective Interest Rate on your investment is 9.3%, not 12%

Some of the big national investors are willing to earn an Effective Interest Rate of only 4-1/2 or 5%.  They will not waste time bidding against you in $100 increments. For the example above, the bidding might start at $500.  The very next bid might be from a national investor, for $36,500.  You will probably drop out of bidding at that point, thinking the investor is crazy. They are not crazy, just efficient.  Why waste time bidding against you, if they are willing to pay a LOT more than you and still meet their investment goals?

Hopefully, the owner will redeem. Under our same example above, the owner will pay the same $1,860.  Of that sum, $1,800 is interest on the excess bid of $36,000. The investor will earn 5% on its excess bid. For big  investors with tens of millions of dollars, that is a great return for a relatively safe investment.

This should not discourage you from bidding at the annual auctions. The big investors don't buy EVERYTHING. If you invest in a wealthy county they find attractive (such as Baldwin County) then wait them out. Start looking at properties owned by people whose name starts with "Z," not with "A." The investors do eventually run out of money in their budgets.

To calculate your maximum bid based on your acceptable Effective Interest Rate, this is what you do:

1. Start with tax assessor's value. Let's assume that is $200,000.

2. Calculate 15% of that value.  That gives us $30,000, which we'll call the Working Money, because it will work to earn interest for you.

3. Calculate 12% (the interest rate) of the Working Money. That gives us $3,600. We'll call that the Earned Interest.

4. Decide the Effective Interest Rate you would be happy earning. Let's suppose that number is 7%.

5. Divide the $3,600 Earned Interest by 0.07 (the Effective Interest Rate), which gives us $51,428.  This is the maximum excess bid you can make and still earn 7% interest on your money when the owner redeems. 

6. Don't forget to add the actual taxes due to the amount of your bid. That will always earn 12% interest.  In actuality, that 12% on the taxes will pull up your effective interest rate a small amount, but I wanted to keep these calculations simple. We'll just ignore that for the time being.

Assuming the taxes due were $1,000, your maximum bid will be $52,428.  If the owner redeems exactly one later, he will pay $1,000 in taxes, plus $120 interest on the taxes, plus $3,600 interest on the excess bid.  You will receive a check for $52,428 (return of your auction bid) plus another $3,720 (interest), for a total of $56,148.  Your effective interest rate will be $3,720 divided by $52,428, or 7.09%

This seems a little bit complicated, but if you will work it through with some examples of your own, it will make more sense.

In real estate, the key to the money is in knowing your numbers.  For tax sale investing, it's the same.

Most Popular Reply

User Stats

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Denise Evans#3 Tax Liens & Mortgage Notes Contributor
  • JD, CCIM , Real Estate Broker
  • Tuscaloosa, AL
1,486
Votes |
1,566
Posts
Denise Evans#3 Tax Liens & Mortgage Notes Contributor
  • JD, CCIM , Real Estate Broker
  • Tuscaloosa, AL
Replied

@James Vega, redemption is complicated in Alabama. There are actually four different redemption time periods, depending on the circumstances. They are not terribly complicated once somebody explains them, but it takes a lot of words to make the explanation. More than I can do in a post.  You might want to read through my blog, reachable from my website, for guidance.

Beyond that, if the owner fails to redeem, then the county keeps the excess bid.  Until very recently, "fortune hunters" were able to find that excess money, partner with the former owner, and claim it for a split. That whole industry went away with 2013 and 2014 amendments to the statute.

3 years after the tax sale, the investor can receive a tax deed. The former owner might still  have redemption rights, but the acquisition of a tax deed means subtle legal differences for the investor.  If the investor has actual possession (itself, or through a tenant) of the property for three years after the tax deed, then that cuts off all possible redemption rights and any ability for the former owner to claim the tax sale was void for technical reasons.

The only exception about cutting off redemption rights with three years of possession is the lienholder redemption rights.  They have an extra time period of one year after the investor sends them certified mail notice at their last known address.  If the investor does not send out that notice until 10 years after the tax sale, then the lienholder still has redemption rights. Most investors send out the notice at the end of the 2nd year after the tax sale, so the owner's regular three year redemption period, and the lienholder's 1 year redemption period, both expire at the same time. As a practical matter, if you want redemption income, you want to wait as long as possible before notifying the lienholder. You don't want them redeeming too quickly, do you?

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