What is a tax lien?
A tax lien is a legal claim placed on a property by the local, state, or federal government. There are two types of tax liens, a federal tax lien, and a property tax lien. So how can these liens help investors make money?
An income tax lien is normally levied when a taxpayer gets behind on their income taxes. These taxes could be state income taxes or federal income taxes. Depending on which, either the IRS or the state treasury will place the lien. A property tax lien is levied when the homeowner falls behind on their property taxes. It is placed on a property when the property owner is no longer paying their property taxes. The lien on the property can then be auctioned off and bought until the lien is removed, which occurs when the taxes are paid off. Investors purchase these liens with the intent of making a profit. Investors can make a profit by charging interest to homeowners if they decide to purchase back the lien. If homeowners do not pay off the lien within an established redemption period, investors can obtain clear title to these properties.
How are tax liens sold?
As mentioned above, liens are usually auctioned off at tax lien auctions. Meaning, that if you want to own one, you may have to compete with other buyers and get involved in bidding wars. These auctions may occur in person or online. A good way to find them is to get in contact with your local tax revenue office for information on auctions. You should also remember that not every state allows the sale of tax lien certificates. Here are the states that do.
When there is an auction, there are two main aspects that can affect the sale. The lien’s interest rate and the premium investors will pay for it. Generally, whoever is willing to purchase the lien with the lowest interest rate and or pay the most expensive premium will be issued the lien. The new lien owner will then collect payments from the property owner with interest in case the property owner decides to pay back their taxes.
What happens when you own a tax lien?
For an investor to obtain a tax lien certificate, they must pay the taxes owed plus any fees or interest.
The property owner can pay the property taxes owed to the investor during a certain period (the redemption period). Typically, between six months to three years. If the owner chooses to pay back the taxes, the investor will receive their investment including interest. If the owner does not pay the back taxes, the investor can begin the foreclosure process. If this process goes through, the investor would then become the new property owner. However, this is uncommon as most homeowners repay their back taxes before the foreclosure is finalized.
Pros and cons
Interest rate – One of the ways to profit from a tax lien is through the payment of interest. Liens can have an interest rate of as high as 18%, depending on the jurisdiction.
Involvement in real estate – Investing in tax liens can be a way for investors to put capital into real estate without actually buying a property. However, in the rare case, the foreclosure process goes through you will end up owning the property.
Competition – Before you even acquire a tax lien, you may have to outbid other competitors. The majority of tax liens require thousands of dollars to be able to purchase and therefore are often bought by institutional investors.
Neglected properties – If investors don’t research the condition of the property itself before obtaining the lien, problems may appear. Usually, the more distressed a property, the less willing the homeowner will be to redeem the taxes. Therefore, the higher likelihood that the investor will end up with the property. In addition, if an investor were to end up owning a distressed property by way of a foreclosure, they may have to pay for the expenses that come with restoring and selling a property.
Expiration – All tax liens expire. If the lien expires before the taxes are paid, the lien holder can’t collect any of the unpaid taxes, leading to a foreclosure. In addition, some properties may have other liens that won’t allow the investor to own the property.
Investing in tax liens can be risky if you don’t do your research. This is why it is important to learn as much as possible. Speaking with your local tax revenue office or tax lien holders can be a good way to start.
Additionally, tax liens can be an alternative to getting involved with real estate. However, it is recommended to have a good understanding of real estate before investing. Knowing what to look for can be crucial when picking a tax lien to invest in. Tax liens can be a profitable investment. This is why it is important to research everything you can about tax liens and real estate in general to maximize your profits.