When an individual or organization fails to pay government taxes, then a legal claim is made against the property. Such a claim is known as a “tax lien.” The local municipality issues a tax lien certificate when a lien is made against a property.
The certificate indicates the amount of taxes owed and any interest or penalties. It’s only once the taxes are paid and the lien is removed that a property owner can sell the property, refinance it, and end the threat of foreclosure.
For this reason, there’s a tremendous imperative to pay off a tax lien, which creates an opportunity for investors.
How Do I Buy a Tax Lien?
In some states, tax liens can be bought and sold at auctions held online or in person. The winning bidder is either the person who is willing to pay the most for the lien or take the least amount of interest on the lien, which will impact how much profit the bidder can make later.;
The lien’s redemption deadline dictates how long the property owner has to pay off their debt. The certificate’s expiration date informs bidders how much time has to pass before foreclosure begins if the property owner doesn’t meet their debt obligations.
How Do I Make Money Investing in Tax Liens?
Buying Tax Liens at an Auction
The way you make a profit from buying a tax lien is that you pay off the outstanding taxes owed, plus any interest and fees. Later, after the property owner makes their property tax payment, you are paid the principal and the interest by the state or municipality.
It usually takes between six months to three years for the property owner to make up all of their payments. Usually, the owner can meet all of their obligations. If the property owner fails to make their payments, then the investor can foreclose on the property, but this doesn’t happen often.
Investing in Tax Liens Through a Fund
Alternatively, you can invest in tax liens using special investment funds set up by investment companies. In this case, you would be one of many investors contributing money to a fund managed by a company or fund manager who would decide what tax liens to buy.;
When researching which fund to invest in, make sure to check the Financial Industry Regulatory Authority’s (FINRA) BrokerCheck to make sure your potential investment fund doesn’t have any complaints lodged against it.
How Do I Find Tax Lien Auctions?
Contact your city or county treasurer’s office, and you’ll discover all the information about the next tax lien auction. You’ll also be able to see the list of all the properties that will be auctioned, plus the rules that govern the auction. The rules will tell you what the preregistration criteria are if any, how you can pay for a tax lien certificate, and more.
In states where tax liens are sold, they’re supposed to be advertised for a predetermined amount of time before the sale. These listings will also include the property owner, a legal description, and the amount of unpaid taxes.
Since more and more companies are investing in liens, it may be harder to place the winning bid at an auction. That may make investing using a lien fund a more viable option.;
How Do I Decide If a Tax Lien is Worth It?
- Divide the total face value of the tax lien and divide it by the value of the property. If the resulting value is greater than 4%, then the lien isn’t worth it.
- Each tax lien has a number that corresponds to its respective asset. You can get information about the asset from the county, often online. You can find out a lot of information that will be useful when making your investment decisions.
- The Property’s Address
- The Owner’s Name
- The Property’s Assessed Value
- The Legal Description
- An Explanation of the Property’s Current State
- Any Structures Located on the Land
- Check the condition of the property. If it’s in bad shape, then that may be a sign that the property’s owner will be unable or unwilling to pay off their debts. Steer clear of any properties that have environmental damage, like chemical or hazardous waste spills or deposits.
What Do I Need to Know Before Investing In Tax Liens?
- The state laws that govern tax lien certificates.
- What information you’re required to provide to the property owner about your tax lien certificate and when. When you’re supposed to send a second notice near the end of the redemption period.
- What the state’s maximum interest rates assigned to tax lien certificates is.
- What asset class you want to invest in.
- What markets you want to invest in.
- How much money you’re willing to invest.
What Are the Risks of Investing in Tax Liens?
The Lien Certificate Expires
Tax liens usually expire after the end of the redemption period. So, it’s possible for your lean to expire before all the taxes have been paid back. You could purchase another tax lien to extend your rights. Otherwise, someone else can purchase a tax lien and collect the interest.
The Property Gets Foreclosed
There’s always the possibility that the property owner won’t pay back their debts irrespective of how much the property is worth. A foreclosure could be an opportunity for you to take over the property, but the legal fees may be cost prohibitive (especially if the reason you’re investing in tax lien certificates is that they’re the most affordable option for you). If you decide to take over, you may have to pay to fix up the home, pay off other liens or claims, and even have to evict the occupants.
What Are the Benefits of Investing in Tax Liens?
Low Barrier to Entry
Investing in property can be expensive. Even investing in REITS can require a hefty buy-in. Investing in tax lien certificates, however, can cost just a few hundred dollars. You can also diversify your portfolio of tax lien certificates by making purchases of different asset classes and/or in different markets.
Predictable Rate of Return
The profit you make from tax liens is based on the interest you collect from the property owner’s payments, which means you can calculate how much you’ll make. Some states also have higher maximum interest rates than others. Florida’s is 18%, while Arizona’s is 2%. That two percent difference can add up!
What’s the Difference Between a Tax Lien and a Tax Deed?
Both tax liens and tax deeds can be bought at auctions. But a tax deed grants someone ownership and interest in a property. If the state has a period of redemption, then the property owner can get their ownership back if they pay back all the taxes. If the state doesn’t have a period of redemption, then the owner of the deed gets the property, and the previous owner’s debts are no more.
Bottom Line
Tax liens are serious business because of the existential threat they pose to someone’s property ownership. The seriousness of a tax lien is what makes it such a good investment, especially when paired with due diligence. It’s no wonder large companies are trying to get in on the action. But if they scoop too many liens out from under you, you can always just invest in their fund yourself!
