One investment niche that is often overlooked by investors is property tax liens. A tax lien is a legal claim against the assets of an individual or business that fails to pay taxes owed to the government. In general, a lien serves as collateral for a debt such as a loan like a mortgage. If the obligation is not satisfied, the creditor may proceed to seize the assets.
But these claims on collateral can also be exchanged and traded among private investors seeking this type of alternative avenue in order to generate above-average returns. In some cases, this unique opportunity can provide knowledgeable investors with excellent rates of return.
Property liens can also carry substantial risk, which means that novice buyers must understand the rules and potential pitfalls that come with this type of asset. This article discusses tax liens, how you can invest in them, and the disadvantages of this type of investment vehicle.
- A tax lien is a claim the government makes on a property when the owner fails to pay the property taxes.
- Liens are sold at auctions that sometimes involve bidding wars.
- If you need to foreclose, there may be other liens against the property that keep you from taking possession.
- If you get the property, there may be unforeseen expenses such as repairs or even evicting the current occupants.
- You can also invest indirectly via property lien funds.
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What Is a Tax Lien?
A tax lien is a legal claim against the property of an individual or business that fails to pay taxes owed to the government. For example, when a landowner or homeowner fails to pay the taxes on their property, the city or county in which the property is located has the authority to place a lien on the property. The lien acts as a legal claim against the property for the unpaid amount that's owed. Property with a lien attached to it cannot be sold or refinanced until the taxes are paid and the lien is removed.
When a lien is issued, a tax lien certificate is created by the municipality that reflects the amount owed on the property, plus any interest or penalties due. These certificates are then auctioned off to the highest bidding investor. Investors can purchase tax liens for as little as a few hundred dollars if it is a very small property. However, the majority cost much more.
Investors can purchase property tax liens from a municipality, allowing them as the new lien owner to collect payments with interest from the property owner. In some cases, they may foreclose and attain title to the property.
Tax Liens by the Numbers
First, let's address growing property tax values. In King County, Washington, property values increased 9% from 2021 to 2022. As a result, a total of $6.79 billion of property taxes were assessed in 2022, an increase of almost $200 million from the year prior. In some counties in Texas, over 95% of Texas residential properties increased at least 20% in value in 2022. In total, governments are assessing more and more property taxes. It's estimated that an additional $328 billion of property taxes were assessed across the United States in 2021.
It's difficult to assess nationwide property tax lien numbers for a few reasons. There is no single governing body over all property taxes; county assessors value your property, and county treasurers collect it. In addition, though aggregated reports exist, they require extensive aggregation of data that may be outdated by the time all information is assembled.
With that said, the National Tax Lien Association estimates the United States generates roughly $21 billion of delinquent property taxes each year. It also estimates that between $4 billion and $6 billion are posted for sale to the private sector each year.
Private reports also show the U.S. tax delinquency rate has relatively been decreasing over the past decade. According to CoreLogic, 6.3% of taxpayers were delinquent on their property taxes in 2021, though this declined to 5.9% in 2021. The states with the highest property taxes were Mississippi, Delaware, and Virginia, while North Dakota, Minnesota, and Wisconsin had the lowest delinquencies.
How Can I Invest in Tax Liens?
Investors can purchase property tax liens the same way actual properties can be bought and sold at auctions. The auctions are held in a physical setting or online, and investors can either bid down on the interest rate on the lien or bid up a premium they will pay for it. The investor who accepts the lowest interest rate or pays the highest premium is awarded the lien. Buyers often get into bidding wars over a given property, which drives down the rate of return that is reaped by the winning buyer.
Buyers of properties with tax liens need to be aware of the cost of repairs, along with any other hidden costs that they may need to pay if they assume ownership of the property. Those who then own these properties may have to deal with unpleasant tasks, such as evicting the current occupants, which may require expensive assistance from a property manager or an attorney.
Anyone interested in purchasing a tax lien should start by deciding on the type of property they'd like to hold a lien on—residential, commercial, undeveloped land, or property with improvements. They can then contact their city or county treasurer's office to find out when, where, and how the next auction will be held. The treasurer’s office can tell the investor where to get a list of property liens that are scheduled to be auctioned, as well as the rules for how the sale will be conducted. These rules will outline any preregistration requirements, accepted methods of payment, and other pertinent details.
Tips for Tax Lien Buyers
Buyers also need to do their due diligence on available properties. In some cases, the current value of the property can be less than the amount of the lien. Investors can analyze risk by dividing the face amount of the delinquent tax lien by the market value of the property, and higher ratio calculations indicate greater risk. Furthermore, there may also be other liens on the property that will prevent the bidder from taking ownership of it.
Every piece of real estate in a given county with a tax lien is assigned a number within its respective parcel. Buyers can look for these liens by number in order to obtain information about them from the county, which can often be done online. For each number, the county has the property address, the name of the owner, the assessed value of the property, the legal description, and a breakdown of the condition of the property, and any structures located on the premises.
Don't invest in tax liens with the expectation that you will get a physical property out of it; about 98% of homeowners redeem the property before the foreclosure process starts.
How to Profit From a Lien
Investors who are interested in locating tax lien investing opportunities should get in touch with their local tax revenue official responsible for the collection of property taxes. There are currently 2,500 jurisdictions cities, townships, or counties that sell public tax debt.
While not every state provides for the public sale of delinquent property taxes, if the state does allow the public auction of the unpaid property tax bill, investors should be able to determine when and where these taxes are published for public review. Property tax sales are required to be advertised for a specified period of time before the sale. Typically, the advertisements list the owner of the property, the legal description, and the amount of delinquent taxes to be sold.
Investors who purchase property tax liens are typically required to immediately pay back the full amount of the lien to the issuing municipality. In all but two states, the tax lien issuer collects the principal, interest, and any penalties; pays the lien certificate holder, and then collects the lien certificate if it’s not on file. The property owner must repay the investor the entire amount of the lien plus interest, which varies from one state to another—but is typically between 10% and 12%. If the investor paid a premium for the lien, this may be added to the amount that is repaid in some instances.
The repayment schedule usually lasts anywhere from six months to three years. In most cases, the owner is able to pay the lien in full. If the owner cannot pay the lien by the deadline, the investor has the authority to foreclose on the property just as the municipality would have, although this happens very rarely.
Investing Passively Through an Institutional Investor
Tax lien investing requires a significant amount of research and due diligence, so it may be worth it to consider investing passively through an institutional investor who is a member of the NTLA. Approximately 80% of tax lien certificates are sold to NTLA members.
To secure membership through NTLA, applicants must pass a background screening process to ensure compliance with NTLA Code of Ethics. Members must also pay member dues of varying amounts based on membership type. Members can participate in member-only webinars, earn a Certified Tax Lien Professional certification, and use the association's online directory to connect with other industry experts.
Disadvantages of Investing in Property Tax Liens
Although property tax liens can yield substantial rates of interest, investors need to do their homework before wading into this arena. Tax liens are generally inappropriate for novice investors or those who have little experience in or knowledge of real estate.
Investors are advised not to purchase liens for properties with environmental damage, such as one where a gas station dumped hazardous material.
Investors also need to become very familiar with the actual property upon which the lien has been placed. This can help them ensure that they will actually be able to collect the money from the owner. A dilapidated or abandoned property located in the heart of a slum neighborhood is probably not a good buy, regardless of the promised interest rate. The property owner may be completely unable or unwilling to pay the tax owed. Properties with any kind of environmental damage, such as from chemicals or hazardous materials that were deposited there, are also generally undesirable.
Not a Passive Investment
Lien owners need to know what their responsibilities are after they receive their certificates. Typically, they must notify the property owner in writing of their purchase within a stated amount of time. They are also usually required to send a second letter of notification to them near the end of the redemption period if payment has not been made in full by that time.
Tax Liens Can Expire
Tax liens are not everlasting instruments. Many have an expiration date after the end of the redemption period. Once the lien expires, the lienholder becomes unable to collect any unpaid balance. If the property goes into foreclosure, the lienholder may discover other liens on the property, which can make it impossible to obtain the title.
Many commercial institutions, such as banks and hedge funds, have become interested in property liens. As a result, they’ve been able to outbid the competition and drive down yields. This has made it harder for individual investors to find profitable liens, and some have given up as a result. However, there are also some funds now available that invest in liens, and this can be a good way for a novice investor to break into this arena with a lower degree of risk.
What Does It Mean If You Have a Tax Lien?
If you have a tax lien, it means that the government has made a legal claim against your property because you have neglected or failed to pay a tax debt. In the case of a property tax lien, you have either neglected or failed to pay the property taxes that you owe to the city or county where your property is located. When this happens, your city or county has the authority to place a lien on the property.
How Does a Tax Lien Sale Work?
Twenty-nine states, plus Washington, DC, the Virgin Islands, and Puerto Rico, allow tax lien sales. Every state uses a slightly different process to perform its tax lien sales.
Usually, after a property owner neglects to pay their taxes, there is a waiting period. Some states wait a few months while other states wait a few years before a tax collector intervenes. After this, the unpaid taxes are auctioned off at a tax lien sale. This can happen online or in a physical location. Sometimes it is the highest bidder that gets the lien against the property. Other auctions award the investor who accepts the lowest interest rate with the lien. Tax collectors use the money that they. earn at the auction to compensate for unpaid back taxes. Once the lien has been transferred to the investor, the homeowner owes them their unpaid property taxes, plus interest (or else they will face foreclosure on their property).
Where Can I Find Tax Liens for Sale?
You can call your county's tax collector directly to find out the process for buying tax liens. Some counties will also advertise the process on their website, as well as providing instructions for how to register as a bidder.
When counties list auctions on their websites, they will also provide information about the properties up for auction, when they go to auction, and the minimum bid. This list can help you identify if there are any properties you are interested in based on their location, property type, size, and minimum bid.
What Happens to a Mortgage in a Tax Lien Sale?
A lien stays with the property when it is sold. Prior to 2017, tax liens used to remain on the previous owner's credit report. However, all three credit bureaus implemented changes that no longer reported civil judgements starting in 2017. By April 2018, all tax liens were removed from all credit reports.
Property tax lien foreclosures occur when governments foreclose properties in their jurisdictions for the delinquent property taxes owed on them. Property tax liens are superior to other liens so their foreclosure eliminates other liens, including a mortgage lien. Homeowners with delinquent taxes typically also have outstanding mortgage debt. After purchasing a tax-foreclosed property, if you discover that there is a mortgage lien on it, it should be removed by the county in which you bought it. The county will discharge the lien based on the tax sale closing documents. In the event that this does not work, you can also contact the lien holder to have it removed.
In every state, after the sale of a tax lien, there is a redemption period (although the length of time varies depending on the state) where the owner of the property can try to redeem their property by paying their delinquent property taxes. However, even if the owner is paying their property taxes, if they fail to make their mortgage payments during this time, the mortgage holder can foreclose on the home.
Are IRS Tax Liens Public Record?
If a legal claim is made against your property in order to satisfy a tax debt, the IRS will file a Notice of Federal Tax Lien. This is a public document and serves as an alert to other creditors that the IRS is asserting a secured claim against your assets. Credit reporting agencies may find the notice and include it in your credit report.
The Bottom Line
Property tax liens can be a viable investment alternative for experienced investors familiar with the real estate market. Those who know what they are doing and take the time to research the properties upon which they buy liens can generate substantial profits over time. However, the potential risks render this arena inappropriate for unsophisticated investors.
Without the proper research and understanding of the real estate market, an investor could easily end up with a property that doesn't get redeemed by the owner (in the form of them paying their taxes to you with interest) and that has no value. That low-value property will then ultimately end up as the property of the investor.
For those interested in investing in real estate, buying tax liens is just one option. Buying a home in foreclosure or buying a home at an auction can also be valuable investment opportunities. If you are still interested in property tax liens, it is recommended that you consult your real estate agent or financial adviser.