Tax lien investing: the good, the bad and the ugly
by Carol Thompson
In some states, when property taxes are delinquent for a certain number of years, a municipality will take title and hold a tax auction, giving immediate ownership to the highest bidder.
In other states, taxing agencies conduct what is known as a tax lien auction, a more complicated way to take possession of a property whereby the taxing authority issues a tax lien certificate investment document.
When purchasing at a property tax auction, when payment is completed, usually within a specified number of days, the taxing authority will sign over the deed and title to the property. The redemption period for the previous owner has ended and the investor has immediate possession in most instances. Less frequent is the need to evict the previous owner.
When purchasing a tax lien, the certificate gives the investor the rights to the tax-related debt associated with a property, plus interest. The taxing authority assigns a fixed rate of interest to each certificate. The holder of the certificate collects interest on the tax debt until it is paid in full. In order to satisfy the tax debt, the taxpayer has to pay the outstanding debt plus interest.
According to Forbes, approximately $426 billion in state and local tax on real estate is owed in the U.S. each year. Twenty-eight states, Washington, D.C., Puerto Rico and the U.S. Virgin Islands allow those liens to be sold to private investors, and about $6 billion in liens come up for sale each year. The local government gets its cash immediately, and the buyer gets the right to collect the delinquent tax, a penalty and interest on the late payment that can run as high as 12 to 36 percent a year, depending on the state.
Interest rates vary by the jurisdiction or state where offered, according to the National Tax Lien Association. Florida offers a maximum interest rate of 18 percent while Alabama offers a fixed rate of 12 percent. Arizona has an interest ceiling of 16 percent and Iowa offers a two percent per month on the unpaid balance.
Although the liens can be a good investment, there are risks. It’s important to check the property prior to bidding. A worthless property will be worthless to the investor. While Google maps can be a useful tool, sometimes the maps aren’t updated, hence, could give a false impression of the property.
It’s also good practice to have a title search performed prior to bidding. There are liens that will trump a tax lien, such as those filed by the federal government.
The tax lien does not give the investor ownership of the property. Any loss of title to real property for unpaid ad valorem real estate taxes must be initiated through tax deed foreclosure proceedings, often requiring an additional capital investment.
Other risks to the investor include bankruptcy, litigation and certificates declared invalid due to procedural errors, according to the National Tax Lien Association.
Only one percent of tax liens end in foreclosure, hence, it is not an ideal situation for real estate investment.
Competition for tax liens is stiff and for purchasers of multiple liens, tracking them can become time consuming.
For now, while bank interest rates are exceedingly low, tax lien investing can result in a better return, however, it’s best to know the playing field before becoming a player. An attractive interest rate can easily be absorbed by difficulties once the investor secures the lien.
Image: Flick: James Malone