And the fact that your post had at least three votes for it when I posted this shows that there are lots of other people who would probably be losing in PA under those same assumptions that just happen to be FALSE in Pennsylvania.Pennsylvania has some rather complicated rules when it comes to tax sales; the particular type of sale that the OP purchased at is one that does not divest any liens; it simply changes the party that is the owner, with the new owner taking title subject to all liens and encumbrances of record.With tax sales, the buyer must be aware of all the local rules under which the tax sale is being conducted, because the rules vary all over the place.Now, what the OP seems to have failed to do in his research was to cross index the recordings at the county recorder; the "missed" mortgage would have showed up on a search by parcel number if that sort of cross check was done (and assuming all indexed documents at the recorder are properly indexed of course - I have seen mistakes made attaching a document to the wrong parcel).

https://www.biggerpockets.com/forums/51-tax-legal-issues-con...

Well, what would be happening is that your buyer would be buying your house subject to the existing note, since you can't legally sell the property without paying off that note or transferring the debt to the new buyer.

The information shared is based on my experience and industry knowledge and should not be considered legal, financial, or investment advice.

Costs include a conversion fee, potential property upgrades, and legal expenses.

Of course not, you still have a legal tenant.

Owners cannot recoup these costs through higher rents, meaning they are effectively being penalized for trying to improve their properties.Instead of discouraging responsible property owners who follow the permitting process and invest in meaningful upgrades, we should be focusing our efforts on ensuring that all renovations are done legally and safely.

For example if one partner added a long-term rental in one party completed a rehab and flip, please properties we need to be filed.

At that time we could renovate the ground floor apartment and potentially turn it into (2) apartments for a total of (5).My questions come down to how do we deal with the existing 40k mortgage, whether we can make it work so her parents aren't paying much in rent, if anything at all, and whether or not we set up any legal entity, like a trust to help the legal situation of paying off her sister down the road. 

Just hire a 3rd party company that takes care of this for you - worth every penny.