Tax lien investing is a way to expand your portfolio and add a unique element to your investments. When property owners don’t pay their property taxes, you may be able to invest in subsequent tax lien certificates. Investing in tax liens is an indirect way to get into real estate investing.
You’re buying tax lien certificates instead of properties, and the hope is that you’ll eventually get a return.
Below, we dive into some of what you should know about this alternative approach to investing in real estate.
What Is a Tax Lien?
A tax lien is created when a local government puts a lien on the property because of unpaid property taxes. Twenty-eight states currently allow the sale of tax lien certificates. There are tens of billions of dollars in delinquent property taxes every year, so opportunities are there for savvy investors.
A tax lien isn’t the same as a mortgage lien. If a property has a mortgage lien, the lender has a claim to the property in question until the borrower pays the loan back. With a tax lien, the government or owner of the tax lien certificate has a claim to the property.
A tax lien is usually something that comes before harsher penalties, like a tax levy. When there’s a tax levy, the IRS or a local government can seize property.
When a local government or municipality issues a tax lien, they create a tax lien certificate. That certificate indicates how much is owed in taxes and any penalties and interest.
Then, the municipality may be able to sell that certificate to private investors. Private investors cover the tax bill, and for that, they get the right to collect that money plus interest when the property owners pay the balance.
Investors Bid In An Auction
An investor in tax liens will have to bid for the certificates in an auction process, and the specifics of how that works depends on the municipality. There is an organization, the National Tax Lien Association, that provides information on what you should know.
They recommend that if you’re interested in investing in liens, you get familiar with the local area. You can contact tax officials in your area to determine how they collect delinquent property taxes.
Bids may be based on a cash amount that someone is willing to pay for a certificate. Bids can also be based on an interest rate they’ll accept. If it’s a cash offer, a certificate goes to the highest bidder. If it’s an interest rate, it goes to the lowest bidder.
The lower the interest rate you bid, the lower your profit.
What If You’re the Winning Bidder?
If you’re the winning bidder, you then take ownership of the lien certificate. You don’t own the property at this point, but you do have the right of ownership through a foreclosure, or you have the right to be paid back if the homeowner covers their tax bill.
You are immediately responsible for paying the tax bill if you win in an auction. You have to pay any owed interest or fees as well. Then, a homeowner has a period of time before what’s called the redemption deadline. They have to pay the investor, or they’re at risk of foreclosure.
Those are the two outcomes—essentially, the homeowner pays their property taxes, or they don’t.
If they do, you get your initial investment back and the interest rate you bid during the auction. If the homeowner doesn’t pay the property taxes, you can start the process of foreclosure.
Most homeowners do end up paying their property tax before it gets to that point.
What Are the Downsides?
There are certainly upsides to investing in tax liens. Namely, you can see significantly better returns than you would on other investments, and it can be a passive investment at least initially.
There are downsides to weigh, too, though.
This is a very risky investment, and you should work with a professional before taking it on.
It can be time-consuming once you purchase a tax lien certificate because there are a lot of deadlines and expiration dates.
Tax lien investing can be lucrative but not something for a person with no experience to dive into without preparing.