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An Introduction to Tax Lien Investing

An Introduction to Tax Lien Investing

Tax lien investing is an overlooked but safe investing strategy that has been around for centuries. State governments created tax liens to collect unpaid property taxes. An underrated form of real estate investing, tax liens are typically a high return investment and a great addition to any investor's portfolio.

If you are looking for ways to diversify your portfolio while potentially realizing considerable returns, tax lien investing may be a viable option to explore. However, as with any investment strategy, it's not without risks. Therefore, it's crucial to educate yourself about how tax lien investing works, including its potential pitfalls, before putting any money on the line.

How Do Tax Liens Work?

Every property owner is required to pay property taxes in the United States. Local governments use property taxes to fund public departments such as police, fire departments, schools, parks, and the construction of roads. In fact, property taxes are often a primary income source for many local counties. When a property owner doesn't pay their taxes, the government needs to find another way to collect that money.

When a property owner doesn't pay their taxes, the county places a tax lien on the property. The county will give the property owner time to pay off their delinquent taxes, but they will send the lien to auction if they fail to pay. The county will hold a public tax lien sale or tax lien auction to sell the tax lien certificate. The certificate price is composed of the delinquent taxes, plus any fees the county paid to bring the certificate to sale. Usually, anyone can attend a tax lien sale. When someone purchases a tax lien at auction, they do not satisfy the property owner's tax liability. They are simply buying a certificate for the amount of the property taxes. This is beneficial for the county because it allows them to continue to fund public programs.

So How Is Tax Lien Investing Beneficial For Investors?

As with any other delinquent payment, the property owner will be penalized for the delinquent taxes. This penalty passes directly on to the tax lien investor. The return is realized when the property owner either pays their taxes or if the property is acquired. If the property owner pays their delinquent taxes, they are responsible for paying the amount of the certificate, plus any accrued interest and fees. The most attractive aspect of tax lien investing is that you will get your money back, plus interest, when the certificate is redeemed. When the county receives the payment from the property owner, they send a redemption check to the investor. 

The payment typically comes in the form of a check or ACH. If the property owner does not pay their taxes, property acquisition becomes possible. Real estate investors will typically pursue this investment strategy because it is possible to acquire properties for a much lower cost than if they were buying it on the traditional market.

Getting Started with Tax Lien Investing

Not all states offer tax lien sales, so the first step in getting started with this investment strategy is finding out whether such sales happen in your state. Here's a current list of states that allow tax lien sales:

  • Alabama
  • Arizona
  • Colorado
  • Florida
  • Illinois
  • Indiana
  • Iowa
  • Kentucky
  • Maryland
  • Mississippi
  • Missouri
  • Montana
  • Nebraska
  • Nevada
  • New Jersey
  • New York
  • Ohio
  • South Carolina
  • South Dakota
  • Vermont
  • West Virginia
  • Wyoming

After confirming whether or not your state allows tax lien sales, follow these steps to get started. A quick note: This type of investing is not recommended for novice investors or for those who are not well acquainted with how real estate works.

  1. Choose a Property Type – Choose a type of property on which to focus your tax lien investing efforts. For example, you might choose to focus on undeveloped land or on improved land; you can also choose between residential real estate and commercial real estate.
  2. Contact the Treasurer – Next, contact the treasurer of the county where you will be bidding on tax liens to find out when and where the next auction will be held. Have them explain to you how such auctions work – are they held online or in person, for example? Obtain a list of rules and requirements for tax lien auctions in that county. In particular, find out what type of payment methods are accepted, and make sure you meet any applicable requirements.
  3. Get a List of Liens for Auction – The treasurer should also supply you with a list of property liens coming up for auction. This is important because it allows you to perform research on those properties and liens before attending the auction, increasing your odds of engaging in effective and lucrative tax lien investing.
  4. Perform Due Diligence – With your list of liens in hand, investigate each one to identify the most promising options. Remember: Not all tax liens are created equal. In fact, it's not unheard of for the value of a tax lien to exceed the value of the underlying property, which dramatically increases your exposure and risk. A good rule of thumb here is to divide the tax lien certificate's face value by the market value of the underlying property. If the resulting ratio exceeds 4%, cross that one off the list. Properties with tax liens are usually assigned a number within the parcels where they are located. Most municipalities allow you to look up information online, so you can visit the county website and search by the applicable reference number. You should then receive an array of information about the property and lien, including the property address; the name of the property owner; the legal description of the property; the assessed value of the property; a listing of any structures that are located on the property and a rundown of the condition of the property.
  5. If You Win at Auction – Armed with the information you have uncovered, attend the auction and bid on the most promising tax liens. If you win, you usually have to pay back the certificate to the county immediately. Now, the property owner is required to repay you for the entire amount of the tax lien plus interest. Interest rates vary by state and range from 5% to 36%; most commonly, they fall between 10% and 12%.
  6. Recoup Your Investment – The property owner must repay the lien within the assigned redemption period, which usually lasts anywhere from six months to three years. The vast majority of the time, the owner repays the amount in full before the redemption period expires. Only around 4% of such properties end up in foreclosure, so investors typically realize their returns through property owners' repayments.

Know the Risks – and Alternatives

As with any investing, it's important to understand the risks of tax lien investing. As noted previously, this type of investing is best suited for seasoned investors with solid knowledge of real estate principles. You must be able and willing to put time and effort into investigating available liens before bidding on them.

Failure to do your due diligence could cause you to lose serious money. For example, as noted previously, the tax lien's value could exceed the value of the underlying property; if the property owner doesn't pay, you will be out the money from the lien and stuck with a property worth less than what you have already paid.

Another thing to look out for is properties with environmental damage or extremely run down and dilapidated properties. The owner of such a property may not be incentivized to pay off any liens that have been placed on it, and you could again end up with a low-value property that could strip away any profit that you hoped to realize. 

Although rare, if you have to foreclose on a property during this process, you may find out that other liens have been placed on it. As the new property owner, you are now on the hook for those liens if you want to sell the property and recoup your investment.

Finally, commercial institutions have jumped onto the tax lien investing bandwagon en masse over the last several years. Big banks and hedge funds, with their massive volume, can easily outbid private investors, driving down the resulting yields. Luckily, an alternative has emerged: funds that invest in tax liens. It's an option that is worth considering, and it may be an excellent way to dip your toe into the pool without getting in over your head.

About The Author

unitedtaxliens

United Tax Liens is a group of experienced, active investors providing everyday people with access to one of the best Real Estate Investment vehicles available today.

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