Earn up to 36% return on your real estate investment within 2 to 3 years. Surprising, isn’t it? Investing in real estate does not always mean purchasing properties. You can opt for tax lien investing and get high returns.
Here’s a detailed guide to investing in property tax liens and how to make money from them.
🚀 Important Facts
- Every year, the local governments offer $4 billion to $6 billion in unpaid tax liens for sale to the private sector.
- Around 26 out of 50 states in the United States allow the sale of tax lien certificates to private investors to recover the tax deficit.
- Bid-down auctions and structuring of tax lien sales by local jurisdictions may limit your return on investment to 9%.
- On average, the lien-to-value ratios are between 3% to 7% that you need to pay to get a tax lien certificate.
What is a Tax Lien?
A tax lien is a legal claim by the local government or municipal authority on a property when the owner fails to pay the property tax debt. Such delinquent properties cannot be sold or refinanced until the dues are cleared.
The notice comes before the IRS or local government steps in and seizes property to recover the debt. The owner is given a chance to pay the dues and get back the ownership of the property. Currently, 26 states allow tax lien certificates sale.
What are Tax Lien Certificates?
The governing authority issues tax lien certificates for delinquent properties mentioning the due amount. These tax certificates are sold in auctions and the final sale amount depends on the property specifics.
The person who wins the bid becomes the holder of the certificate and must pay the due amount. Each certificate has an expiry date. The original owner is supposed to pay the dues within that duration to the investor.
The period can vary from 3 months to 3 years. In the meantime, the investor gets interest on the amount invested. If the original owner fails to pay the due amount on time, the investor can foreclose on the property and become its owner.
Tax Lien States
Tax lien certificates are not sold in every state. Check out the list of tax lien states with their interest rate and redemption limits. (Data: TaxLienCertificates.com)
| Sr. No. | State | Interest Rate Limit | Redemption Limit |
|---|---|---|---|
| 1. | Alabama | 12% | 3 years |
| 2. | Arizona | 16% | 3 years |
| 3. | California | 18% | 2 or 3 years |
| 4. | Colorado | 11% | 3 years |
| 5. | District of Columbia | 18% | 6 months |
| 6. | Florida | 18% | 2 years |
| 7. | Illinois | 36% | 2 years |
| 8. | Indiana | 10% - 15% | 1 year |
| 9. | Iowa | 24% | 2 years |
| 10. | Kentucky | 12% | 1 year |
| 11. | Louisiana | 12% | 3 years |
| 12. | Maryland | 6% - 24% | 6 months/ 2years |
| 13. | Massachusetts | 16% | 6 months |
| 14. | Mississippi | 18% | 2 years |
| 15. | Missouri | 10% | 1 year |
| 16. | Montana | 10% | 2 or 3 years |
| 17. | Nebraska | 14% | 3 years |
| 18. | Nevada | 12% | 4 months/ 2 years |
| 19. | New Jersey | 18% | 2 years |
| 20. | New York | 14% | 1 year |
| 21. | Ohio | 18% | 1 year |
| 22. | Rhode Island | 16% | 1 year |
| 23. | South Carolina | 8% - 12% | 1 year to 18 months |
| 24. | Vermont | 12% | 1 year |
| 25. | West Virginia | 12% | 17 months |
| 26. | Wyoming | 18% | 4 years |
Are Tax Liens a Good Investment?
Yes, tax liens are a good investment because you get assured returns on investment. The ROI is between 10% to 36% as offered by states which is remarkable. However, these are maximum figures and the actual rates may vary.
Most tax liens are sold between 3% to 7% interest rates at auctions according to the NTLA. In the United States, $21 billion of property taxes become delinquent every year. This is a great opportunity to invest and earn great returns in a short time.
But don’t forget to check the delinquent property’s condition before investing in tax liens. You may end up foreclosing on the property if the original owner does not pay the dues.
Suppose the property is just swamp land or vacant property that is dilapidated. You will not be able to sell it easily or do much with it.
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How to Invest in Tax Liens?
If you are wondering how tax lien investing works, you must know that it is much different from investing in bonds or stocks. Here are the steps you need to follow to purchase tax liens and get returns:
Step 1: Look out for Tax Lien Certificates for Sale
If an owner fails to pay property taxes on time, a lien is placed on the tax lien property by the government or municipality. They create a tax lien certificate that specifies the back taxes owed on property, interest, or penalty amounts that need to be cleared.
In case the owner does not pay the total amount even after certificate generation, the certificate is available to the public for purchase through auction. Be on the lookout for such announcements in the local newspaper or county websites.
📌 Important: Check the interest rate and certificate expiry date before going to an auction.
Step 2: Attend the Tax Liens Auction
Private investors get a chance to bid for the certificate through an auction that the governing authority conducts. By selling tax lien certificates, the government recovers the tax deficit amount quickly.
The owner gets an extension for paying back taxes on property to the investor and the investor gets interest on the amount invested. Scout delinquent properties carefully before attending an auction so that you don’t end up paying more than the property value.
Step 3: Bid for the Tax Lien Certificate
During the auction, different private investors bid for the certificate. The final sale amount depends on the condition of the property. You can participate in the bidding process and bid carefully to get the best deal.
Make sure you are prepared with your bidding limit so that you don’t overpay. Also, check the payment requirements set by the government so that you are ready to pay if your bid is accepted.
Step 4: Win the Bid and Acquire the Certificate
After the bidding process is over, the organizers announce the winner. If you win the bid, you become the holder of the tax lien certificate. You become liable to pay the due amount mentioned on the certificate to the government.
Follow the local laws and proceed accordingly after getting the certificate. You might have to notify the original owner by sending an official letter in which the amount they owe you is mentioned.
Step 5: Pay the Taxes Owed
After acquiring the tax lien certificate, the first thing you need to do is clear the due amount along with any accrued penalties of the original owner. The government recovers the deficit amount.
They then give you the right to collect the same amount from the owner along with the interest rate you bid at the auction. The duration of repayment varies from a few months to 3 years depending on state laws.
The interest rate limit also varies by state but the final rate is decided during the bidding.
Step 6: Collect Payment from Homeowner or Foreclose
After you pay off the due amount, you have to wait for the owner to repay the amount. There are two possibilities- the owner may or may not pay within the stipulated time.
In the first scenario, you simply have to collect the amount you paid along with the interest at the rate decided during the auction. In case the owner is unable to repay the dues and the interest, you have the right to initiate the foreclosure process.
Title transfer is only possible when the court orders the tax foreclosure auction. However, the procedure usually ends with the lien holder becoming the property owner. You may have to invest additional capital before you get ownership rights.
📌 Important: Be careful of the certificate expiry date because you may have to foreclose before a particular date as per the law. If you miss the date, you will end up losing your initial investment.
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✍️ Pro Tip
Don’t invest in tax liens with the expectation of becoming a property owner. 98% of property owners pay the due amount within the deadline and redeem their properties. Foreclosure is very rare.
Investing Passively in Tax Liens
After understanding the entire process, if you feel that tax liens or tax yields investing requires expertise, you can invest passively. You can approach an institutional investor who is a member of the NTLA (National Tax Lien Association).
A vital fact you should be aware of is that 80% of the tax lien certificates are sold to members of the NTLA. Among these, there are many tax lien fund managers. You can get in touch with NTLA for referrals and invest through a fund manager.
This is a good way to secure your investment and get assured returns without complications.
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❗Warning
Tax Lien Investing is not risk-free. You may lose money if the owner declares bankruptcy, does not redeem the tax lien, the government decares the certificate invalid, or other liens are given priority. You may get less than expected or no ROI.
How to Profit from Tax Lien Investing?
Tax lien investment has its share of risk. To make sure that you walk away with a good return on your investment, follow this checklist:
- Go through the local newspapers and county websites for tax lien sales notifications
- Shortlist properties that seem worth investing in and check the tax liability
- Compare the tax liens of the shortlisted properties to see which are affordable
- Scout the properties before the auction and select the ones in good condition
- Note down the auction dates and the method of payment
- Attend the auction, bid as per the property’s actual worth, and get a good interest rate
- Pay the tax lien amount with accrued interest and penalty
- Check the certificate expiry date and foreclosure provisions
- Make sure you get repaid within the stipulated time
- Approach the certificate issuer in case of non-payment to begin foreclosure
- Secure the title deed to become the owner of the property
You can also invest through an institutional investor to secure your investment and avoid hassle.
Advantages of Investing in Tax Liens
- Low Capital Requirement: You can invest in tax liens for as low as a couple of hundred dollars, depending on the property’s value. That’s a much lower capital requirement compared to other investments given the return that you can get.
- High Return on Investment: You can earn 16%, 18%, 24%, or even 36% interest on your investment depending on the bidding process. The best part is that the interest rate is fixed and the investment is not subject to any market fluctuation.
- Lumpsum Returns: After the resolution of the tax lien, you get back not just the principal amount but also the interest. The lumpsum payment at the end can finance your future investments.
Disadvantages of Investing in Tax Liens
- Subsequent Liens: There is a possibility that you may be compelled to purchase any other liens on the property after purchasing the initial lien. This may require further capital investment. Also note, new liens get more priority than old ones.
- Neglected Property: Sometimes the delinquent properties are located in areas with environmental damage or hazards. The owners of such properties may never be able to repay the dues. You may never recover your investment.
- Competitive Bidding: The tax liens bidding process is very competitive because of potentially high returns with low investments. You can lose out on good deals to fund managers and other investors.
Powerful Tips for Tax Lien Certificate Investing
- Target Low-cost Tax Liens: You can avoid competition by bidding for low-cost tax liens. Fund managers are generally interested in tax-yield investments with higher sale prices and returns.
- Check the Return on Investment: The limits on interest and the tax lien certificate sale value vary by state. This can affect your potential profit. Calculate your ROI and invest accordingly.
- Get Familiar with Local Laws: Go through the county website for detailed information on the local laws for tax lien sales before investing. Your experience of buying tax liens may be easy or difficult depending on your location.
- Diversify Your Investments: Investing in tax liens involves risk although it has several benefits too. Identify other investment options and invest smartly to diversify your portfolio and minimize the risk.
Tax Lien Investing vs Tax Deed Investing
Tax liens and tax deeds both convey non-payment of property taxes by the owner. The main difference is in terms of the rights given to the investor.
| Parameters | Tax Lien Investing | Tax Deed Investing |
|---|---|---|
| Investor Rights | You have the right to collect the invested amount with interest from the owner. If the owner does not pay on time, you can foreclose. | You get the ownership of the delinquent property. You are free to use the property as you wish immediately after title transfer and possession. |
| Investment Amount | A tax lien requires less investment than a tax deed because you only have to pay the tax deficit. You are not responsible for the property's upkeep. | Purchasing a tax deed requires you to pay the tax debt as well as additional investment to make the property ready for sale in the future. |
| Type of Investment | Tax lien investing is a passive investment because you don’t own the property and are not responsible for its upkeep. | Tax deed investment requires you to actively manage the property and prepare it for sale if you don’t want to use it. |
📌 Important: Even though tax deed investment costs more time and money, it gives greater returns than tax lien investing.
Tax Lien vs Mortgage Lien
Tax liens differ from mortgage liens. The claim to a tax liens property is with the government or tax lien certificate owner in the first case and with the mortgage lender in the second case.
Tax liens imply property tax dues owed to the government whereas mortgage lien is the amount of loan to be repaid to the lender. To recover the tax lien, the government can issue certificates, sell them at tax lien auctions and recover the due amount.
The holder of the certificate can foreclose on the property if the owner does not repay the due amount before the certificate expiry. Mortgage liens have to be paid in monthly installments and are fixed amounts.
In case of non-payment of the mortgage, the owner can opt for mortgage refinancing. If that is not possible, they can sell the property to repay the amount instead of letting the lender claim right over the property.
Bottom Line
Tax lien investing is a lucrative option to earn a good ROI. You can earn a substantial interest on your share of the $21 billion worth of property taxes that become delinquent annually.
However, familiarize yourself with the local laws and scout properties carefully before buying property tax liens. Get the best returns in a limited time with minimal investment.
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Frequently Asked Questions
1. How to buy a property with delinquent taxes?
You have to participate in the auction of tax deeds conducted by the local government. After you win the bid, a percentage of the deed sale will repay the tax debt. You can also directly approach the homeowner and make an offer of purchase.
2. How to find tax lien properties?
Information about tax lien houses is generally published in the newspaper. If your state does not sell tax liens or tax deeds, you need to check the websites of the counties. You will get the list of tax-delinquent properties for sale.
3. Is there any tax lien loophole?
In the Illinois statute, a ‘sale in error’ provision allows investors to buy tax liens and sell them back to the owners if there is an error in the information provided during the sale. Investors get a full refund with interest, making easy money because of listing errors.
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