Should You Invest in Tax Liens?
If someone fails to pay their real estate taxes on time, you could profit.
There are many ways to make money in real estate. You can own properties outright and sell them at a profit. You can purchase them and earn rental income. You can buy shares of real estate stocks or funds.
It’s also possible to make money when property owners fail to pay their taxes. If a municipality places a tax lien on a property, an individual can buy that tax lien and then collect the taxes and interest from the owner.
This type of investing can be lucrative, but it’s also complex and potentially risky. If you are considering tax lien investing, here are some key things you should know before taking the plunge.
How Tax Lien Investing Works
It all starts when someone fails to pay the necessary taxes on property they own. Once this happens, a municipality will place a lien on that property. This means the property can’t be sold until the taxes are paid and the lien is removed.
Currently, 29 states and the District of Columbia allow tax lien certificates to investors through an auction process. Roughly 2,500 cities, townships, and counties sell public tax debt, according to the National Tax Lien Association.
Municipalities do this because they will receive cash immediately for delinquent taxes. The sale of tax lien certificates also helps homeowners, because it provides them time during which they can pay the owed taxes.
During the auction process, investors will compete to see who will accept the lowest interest rate or bid the highest premium for the tax lien. The goal of the investor is to collect the taxes plus associated interest on the lien, and hope it results in more money than what they paid.
Tax lien investors make money from the interest on the liens, and this can prove to be quite lucrative because rates are often high. Rates can be bid down at auction, but (to offer a few examples) they could be as high as 18% annually in Florida, 12% in Alabama, and 16% in Arizona.
The property owner has a redemption period during which they can pay the required taxes plus interest. This typically ranges from one to three years depending on the state. But sometimes, the property owner does not ultimately pay the tax lien. When this happens, the owner of the tax lien has the right to foreclose on the property and take ownership of the home. Thus, tax lien investing can be one way to acquire properties for less than they would normally be worth on the open market.
Tax lien investing isn’t as simple as buying the certificate and sitting back and collecting money. As the owner of the tax lien certificate, you have certain obligations that vary depending on where you are.
It’s also vital to remember that tax liens expire. The expiration date varies depending on the municipality and the type of lien.
So if you think that you can just hold onto a lien for a long time and eventually foreclose if you don’t get your money, you may be in for a rude awakening. When the lien expires, all of your rights to collect also expire.
Depending on the location, there may be a host of rules governing communication with the property owner. They must usually notify the property owner that they have purchased the tax lien certificate. They are then also required to notify the owner that a redemption period is coming to an end.
Tax lien investing isn’t easy. For one thing, auctions can be quite competitive, and it’s easy to find yourself buying a lien at unfavorable terms. Sometimes, interest rates get bid down so low that buying a tax lien is no more profitable than putting money in the bank. In fact, tax liens can sometimes be larger than the value of the property itself.
It’s also crucial to have a good understanding of the physical condition of the property you are buying. Is the property located in an area where foreclosures are high? Is there hazardous material or environmental problems on the property?
This type of information matters, because if you do end up owning the property due to foreclosure, you may be responsible for costly maintenance and cleanup.
You must always be aware that you may never end up collecting a dime in taxes or interest. Many property owners simply don’t pay. Others will declare bankruptcy. If this happens, you should be open to the idea of foreclosing on the property. If you are not prepared to take over the expense and work of property ownership, tax lien investing may not be for you.
Tax Lien Fund
One potential way to invest in tax lien certificates with less risk and effort is through special investment funds.
Some investment companies have set up private placement funds that invest in tax lien certificates. In this case, you may be pooling your money with other investors, and an investment company or fund manager is making the decisions on what tax liens to purchase.
For example, Kite Capital Partners is one company that has been investing in tax liens through a fund since 2009. Its first tax lien fund was liquidated in 2011 and provided investors with a 14.1% annualized rate of return, according to the company.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.
Lake County Ohio Treasury. "Tax Lien Certificate Sales," Page 4. Accessed Oct. 21, 2020.
National Tax Lien Association. "Common Questions About Tax Liens." Accessed Oct. 21, 2020.
Office of the County Clerk, Lake County Illinois. "Tax Redemption Process." Accessed Oct. 21, 2020.
Kite Capital Partners. "Portfolio." Accessed Oct. 21, 2020.