Property tax liens are an investment niche that is overlooked by most investors. Purchasing tax liens can be a lucrative though relatively risky business for those who are knowledgeable about real estate.
When individuals or businesses fail to pay their property taxes, the municipalities or other government bodies that are owed those taxes place liens against the properties. Rather than pursuing the cases further, the government auctions off the liens at real-world or virtual auctions.
These claims on collateral are also exchanged among investors who hope to generate above-average returns.
Through this process, the municipality gets its taxes and the investor gets the right to collect the amount due plus interest from the debtor. The process rarely ends with the investor seizing ownership of the property.
Key Takeaways
- Atax lienis 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.
What Is a Tax Lien?
A tax lien is a legal claim against the assets of individuals or businesses that fail to pay taxes owed to a local, state, or federal tax agency. It effectively ties up the property and prevents its sale until the owner pays the taxes owed or the property is seized by the creditor.
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 bidder.
Investors can purchase tax liens for as little as a few hundred dollars if it is a very small property though the majority cost much more.
If you purchase property tax liens, do you own the property?
Investors who purchase property tax liens earn their profit through payments of back taxes plus interest by the property owner. The process rarely ends with the lien holder attaining ownership of the property.
Tax Liens by the Numbers
First, consider growing property tax values. In King County, Washington, property values increased by 9% from 2021 to 2022. A total of $6.79 billion in property taxes was assessed in 2022, an increase of almost $200 million from the year prior. In some counties in Texas, more than 95% of residential properties increased at least 20% in value in 2022.
Higher valuations mean higher taxes. It's estimated that an additional $328 billion of property taxes was assessed across the U.S. in 2021.
The trend continues. Taxes on single-family homes were estimated to rise an average of 3.6% in 2022, to a total of $339.8 billion, and by 6.9% in 2023, to $363.3 billion.
Delinquency Rates
It's difficult to assess nationwide property tax lien numbers. There is no single governing body; county assessors value your property and county treasurers collect it.
Aggregated reports exist, but they require so long to compile that they may be outdated by the time the information is assembled.
That said, the National Tax Lien Association estimates that roughly $21 billion of delinquent property taxes are created 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 been decreasing over the past decade.
According to CoreLogic, 5.9% of all property taxpayers were delinquent in 2021, a decline from 6.3% in the previous year. The states with the highest property tax delinquency rates 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 in much the same way actual properties are 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.
Problems to Look Out for
Buyers of properties with tax liens need to be aware of the cost of repairs along with any other hidden costs that they may face if they assume ownership of the property.
The new owners of these properties may have further legal hurdles, possibly including the need to evict the current occupants with the help of an attorney, a property manager, the local police, or all three.
Steps to Take Before Bidding
Anyone interested in purchasing a tax lien should start by deciding on the type of property they'd like to bid on—residential, commercial, undeveloped land, or property with improvements.
The city or county treasurer's office will know when and where the next auction will be held.
The treasurer’s office will also know where investors can find a list of propertyliens that are scheduled to be auctioned and 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 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. Higher ratio calculations indicate greater risk.
It's important to check for 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 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 it.
Don't invest in tax liens with the expectation that you will get ownership of the physical property. About 98% of homeowners redeem the property before the foreclosure process starts.
How to Profit From a Lien
There are about 2,500 jurisdictions cities, townships, or counties that sell public tax debt. Investors who are interested in locating tax lien investing opportunities should get in touch with the local tax revenue official responsible for the collection of property taxes.
While not every state provides for the public sale of delinquent property taxes, if the state does allow 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 before the sale. Typically, the advertisem*nts list the owner of the property, the legal description, and the amount of delinquent taxes to be sold.
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 the vast majority of 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. This rarely happens.
Investors need to become very familiar with the actual property upon which the lien has been placed. This can help them ensure that they will be able to collect the money from the owner.
Beware of Neglected Properties
A dilapidated or abandoned property located in a rundown neighborhood is probably not a good buy, regardless of the promised interest rate. The property owner may be unable or unwilling to pay the tax owed.
Properties with any kind of environmental damage, like hazardous material deposits, are also undesirable.
Responsibilities of Lien Owner
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 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.
Investing Passively Through an Institutional Investor
Given the amount of research and due diligence involved in tax lien investing, it's worth considering investing passively through an institutional investor who is a member of the National Tax Lien Association (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 the 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 and perhaps take a course before wading into this arena.
Tax liens are generally not appropriate for investors who have little experience in or knowledge ofreal estate.
Investors are advised not to purchase liens for properties with environmental damage, such as former gas station sites where hazardous material was dumped.
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.
There's Big Competition
Many commercial institutions, such as banks and hedge funds, have become interested in property liens. 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.
If You Pay Someone's Property Taxes Do You Own the Property?
Investors who buy tax liens rarely seize ownership of the property. In most cases, the lien holder and the property owner reach an agreement on a schedule for repayment of the amount due plus interest.
Seizure of the property is a last resort when the property owner is unwilling or unable to pay the debt.
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.
Once the lien has been transferred to the investor, the homeowner owes the investor the unpaid property taxes plus interest.
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 advertise the dates and the process on their websites.
When counties list auctions on their websites, they will provide information about the properties up for auction and the minimum bids for each property.
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 judgments 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.
If 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 during which the owner of the property can try to redeem the property by paying the delinquent property taxes. However, even if the owner is paying their property taxes, the mortgage holder can foreclose on the home if the mortgage is delinquent.
Are IRS Tax Liens Public Record?
If a legalclaim is madeagainst 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.
