In New Jersey, tax sale certificates are required to be sold by municipalities if a property owner fails to pay his/ her property taxes. The municipal tax collector holds a public sale (after advertisement/ posting) and then sells the Tax Sale Certificate (TSC) to the highest bidder at a public tax sale. Bidding actually goes “down” and not “up”, meaning that bidders compete against one another based upon the interest rate they are willing to accept – starting at 18% and then going down. If someone bids down to 15% interest, they can be outbid by someone who bids 10% interest, and so forth. Once you win the bid, you essentially earn three (3) distinct rights: (a) the right to receive back your principal, plus sale/ recording costs, plus interest; (b) the right to pay “subsequent” delinquent taxes on that property and earn interest on those amounts paid (usually 18% regardless of the initial rate applicable to the initial TSC amount); and (c) the right to foreclose if not redeemed within the applicable time period.
The TSC enjoys a first priority lien against the subject property, and it permits you to “foreclose out” any other interests if you are not re-paid (redeemed) within the applicable time period, with very few exceptions. The time period of waiting is usually 2 years, but can be accelerated in some situations (e.g., you can institute a foreclosure case on vacant or abandoned property after 6 months from issuance of the TSC). There are some exceptions as to what you can foreclose-out, but not many. For instance, if the Federal government (e.g., IRS) has a lien against the property you can still wipe it out in your TSC foreclosure but you have to follow a special procedure and send it to a Sheriff Sale (which is not required for standard tax foreclosures without Federal liens). Otherwise (with one rare exception under the NJ Spill Compensation Act for liens held by the Department of Environmental Protection), a TSC foreclosure action will generally wipe out all other liens and judgments – even if they came about (and even if they were recorded) first in time and prior to the TSC.
By way of example, let’s consider a residential property owner who has a $75,000 mortgage and 2 monetary judgments against him. In this example, the owner fails to pay his property taxes, and his mortgage company likewise does not pay the taxes. If you are the successful bidder and acquire a TSC at a public tax sale, you can pay his delinquent taxes for the following 2 years and then you can foreclose after 2 years -- and you can also name the mortgage company and the 2 judgment creditors. If no redemption is made during the lawsuit, then upon entry of tax foreclosure Final Judgment you are vested with a “fee simple” interest in the property that bars all other parties from redemption. Translated into non-legalese: you own deed title to the property and all other interests (mortgages, judgments, etc.) are stripped from the title and your title is clear and unencumbered. This does not mean that the 2 judgment creditors can get no money from the former owner; they can continue to try to collect from that prior owner (levy upon bank accounts, file a wage garnishment, etc.) but this subject property will no longer be encumbered by, or subject to, the judgment liens or the mortgage.
With a first priority lien, bidders at public tax sales are not required to conduct title searches before they bid. Essentially, it does not matter what else lies against the property. If there are mortgages, judgments and liens, the TSC skips to the top of the list, right? So why worry about conducting a title search? Well, there might be instances where you want to know the “uses” of the property – including the existence of any encumbrances or easements. These easements generally cannot be foreclosed. For instance, if the property has a utility easement (e.g., public sewer line that runs underneath a portion of the property) then this easement will remain after a tax foreclosure judgment. The same holds true for "use" easements – such as farmland designations. But these easements do not prevent “foreclosure”. You can still foreclose and obtain fee simple title; it is just that your new title will remain subject to the easement.
A recent Appellate case was argued (still pending before the Appellate Court) where this issue was heavily discussed. A property owner in Howell, NJ, obtained a farmland grant in 1999 that covered her 3 adjacent lots. The farmland easement said that (a) the property needs to be kept as farmland in perpetuity, and (b) the property cannot be divided and must have a common owner. Unfortunately, neither the owner nor the farmland program conducted “lot consolidation” on the 3 lots. It was left as 3 separate lots with the same one owner who just received her farmland grant. One of the lots was entirely farmland and owed only $29 per year in taxes. The other 2 lots had residential portions and farmland portions, and they each owed about $6,000 per year in taxes. The property owner then had the shrewd idea to pay only the $29 and leave the $12,000 unpaid, so that 3 tax liens could never be sold because she always paid the taxes on the small lot. The tax collector then sold TSCs against the other 2 lots, because the law mandates the sale of a TSC on any tax deficiency. After 2 years, the TSC holder sought to foreclose on 1 of those larger lots and the farmland program (not the owner) fought against foreclosure and said that the farmland easement at sub-part (b) prevented division of the property. If the foreclosure was successful, obviously the property would be "divided" because that lot would have a different owner and it would violate the "common owner" deed restriction.
The farmland program urged the Court to consider that the TSC owner “took the risk” and “knew what they were buying” when they bid upon the TSC with an existing farmland easement. The TSC holder argued, in opposition, that the property always remains subject to the farmland easement, but there is no prohibition against foreclosure and the division of the property because a recorded easement and language therein against division cannot trump a statutory enactment that allows a TSC to foreclose and obtain fee simple title against an owner for unpaid taxes. Moreover, the TSC holder never “knows” at the time of the public sale of any such encumbrances or division restrictions since title searches are never conducted prior to bidding: it would be too costly (hundreds of dollars per search) and, as mentioned above, the knowledge of title does not really matter because TSCs enjoy first priority liens over everything else (except DEP spill liens, which have a separate internet listing and do not require title searches in order to perform due diligence before a public tax sale).
The Appellate Court has not yet ruled, although it would be a shock and would create reverberations throughout all municipalities (and amongst all TSC bidders) if the decision was ultimately not in favor of the TSC and the right to foreclose. The farmland program knew what it should have done to avoid this problem –and it should have consolidated the 3 lots so that only 1 tax bill was generated so that the non-divisibility and common ownership mandates could be honored. The TSC should be permitted to foreclose and the deed restriction cannot prevent separate ownership in this instance, but the new owner (TSC holder) remains subject to using that designated portion of land as only farmland in conformity with the easement.
This case again raises the question as to whether or not a TSC bidder should conduct a title search prior to bidding. These types of issues can arise in the tax foreclosure context. Restrictions on use of land and sale of land may exist. Most (if not all) of those easements will not prevent a foreclosure judgment; but they will not necessarily be wiped out by the judgment and will likely continue to exist against the new owner. The question of whether or not to conduct a title search might very well rest upon the type of property you are bidding upon: large? small? valuable? developed vs. undeveloped? and ultimately how risk-averse are you? Yes, you can foreclose under the laws; but will you be left with something that is usable and sellable as a real estate investor? Will an existing easement restrict your future actions with the property? Some of these are easy answers. If you are bidding upon a residential property in an age-restricted development then you already know that if you foreclose you can only subsequently sell the property to someone above age 55. But some deed restrictions and easements might not be that clear (e.g., in the above-motioned case you might not know that upon foreclosure you can only develop a small portion of the property and the remainder might remain designated as “farmland” in perpetuity). In sum, there is no short answer to the question as to whether or not to do a title search. You can foreclose, and in no instance should a deed restriction stop your statutory rights under the foreclosure laws (this writer’s opinion is still awaiting the Appellate Court’s agreement in the above-mentioned case); but you can also be subject to restrictions upon foreclosure that can limit your use (and possible development) of the property. This is important - especially to those people in the industry of real estate investment and development. Being aware of these potential issues is always well advised prior to engaging in public bidding upon TSCs.
Anthony L. Velasquez, Esq., is an attorney in New Jersey practicing extensively in the areas of tax foreclosure and real estate litigation