What Is a Tax Lien Certificate?

Tax Lien Certificates Explained

An investor looks over tax lien certificates in her city.
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A tax lien certificate is a legal document that allows the holder to collect outstanding property taxes owed for a piece of real estate. Tax lien certificates can accrue interest, which make them an attractive investment tool for individuals who choose to purchase them. 

Learn how tax lien certificates work, plus some benefits and risks, before adding them to your portfolio.

Definition and Examples of Tax Lien Certificates

Tax lien certificates represent a form of debt that's tied to real estate.

  • Alternate names: tax executions, certificates of purchase, tax sale certificates

The National Tax Lien Association (NTLA) describes tax liens as “instruments offered for sale by local county and municipal governments as a method of recovering property tax dollars deemed delinquent due to the property owner's failure to satisfy the debt."

In other words, when a property owner fails to pay their property taxes, a state or local tax agency can place a lien on the property. This lien prevents the property owner from selling or refinancing the property until they pay the tax debt. 

County and municipal governments create a tax lien certificate that states how much is owed in property taxes, along with any interest or penalties due.

These certificates can then go to auction for investors, allowing the governments to collect payment on the past-due taxes, interest, and penalties. 

Tax lien certificates can only transfer ownership of property tax debts, not the property itself. 

How Tax Lien Certificates Work

When a property owner fails to pay their property taxes, a tax agency can issue a tax lien certificate. These certificates can then be sold through an auction format.

Only some states list tax liens for sale at public auction. They’re generally sold to the bidder who offers either:

  • The lowest interest rate
  • The highest cash offer

When you purchase a tax lien certificate, you assume responsibility for paying the outstanding lien amount along with interest or penalties due.

Then, when the property owner pays their property taxes, the state or municipality that issued the tax lien certificate pays you principal and interest amounts.

Before bidding on a tax lien, learn more about investing in tax lien certificates.

Benefits and Risks of Tax Lien Certificates

For Homeowners

Tax lien certificates can be problematic for several reasons.

First, having a tax lien certificate outstanding means that you'll not only be responsible for repaying the past-due taxes but the interest and penalties as well. This can add to the cost of owning the property. 

Next, and more importantly, failure to redeem a tax lien certificate by paying what's owed could lead to a foreclosure filing. This could mean losing the property, as well as significant damage to your credit score

For Investors

Tax lien certificates can be useful for diversifying a portfolio. From an earnings perspective, returns are based on the interest rate the property owner pays you, and they can be consistent.

For example, if you hold a tax lien certificate in a state with a higher maximum interest rate, your investment could see a good rate of return, especially if the interest rate is higher than you might earn in a fund that tracks an index.

Tax lien certificates can be risky, however. If a property is valued at less than what's owed in taxes, the owner may not be motivated to pay the amount due.

You could then be responsible for the foreclosed home, which may not be ideal if it involves added costs to improve the home so it can be resold. Tax liens typically have an expiration date, so lienholder rights to interest and penalties don't last indefinitely. 

Key Takeaways

  • A tax lien certificate represents a debt associated with unpaid property taxes. 
  • Property owners have a set time frame in which to pay outstanding property taxes before a tax lien certificate holder can initiate a foreclosure proceeding. 
  • Tax liens can be costly to property owners, though they can yield returns to investors. 
  • Before investing in tax lien certificates, it's important to understand the risks.