Tax lien investing has become a popular method of investing in real estate but it should not be taken lightly. Although potential returns are huge, so are the risks.
Tax lien laws vary greatly from state to state and you absolutely must understand the laws in the state and even the county before investing. Basically, a lien is placed against a property when the owner fails to pay the property tax. Counties are highly dependant on property taxes to deliver the services people depend on. To maintain a reliable income from property taxes, many (but not all) counties sell these liens to investors. These liens carry a high interest rate that then becomes owed to the investor. That’s on the pro side of tax lien investing.
Pros to Tax Lien Investing
High interest rates and the possibility of acquiring property for the cost of back taxes are by far the biggest reasons investors buy tax liens. The National Tax Lien Association estimates that between $7 and $10 billion in property taxes go unpaid each year. Typically, the interest rate on these loans ranges from 12% to 24%.
How long property owners have to pay the delinquent taxes varies across the county from six months to three years. Also, the final solution to collecting the taxes varies. Some states allow the lien holder to foreclose on the property. Taking ownership can be attractive to investors if the property is significantly more valuable that what was paid for the tax lien. Other states auction the property and repay the investor for the back taxes plus the interest owed.
But there are serious potential down sides…
Cons to Tax Lien Investing
The biggest risk when paying someone else’s property taxes is the property owner could very well be going into or already in bankruptcy. You might think that’s no big deal since the property can be auctioned. However, people in bankruptcy typically also owe IRS federal taxes. The IRS will place a lien on the property and IRS liens override all other liens. If the property doesn’t sell for more than what is owed to the IRS the investor gets nothing.
Also, consider why an owner might not being paying the property taxes. Real estate values have dropped all across the country. The value of the property may be significantly less than it once was. The owner may have been trying to sell the property for months or even years. The property simply will not sell or is worth less than what is owed on the mortgage, so the owner stops paying taxes and allows the property to go into foreclosure. If this is the case, the probability of the investor recovering the tax lien is not realistic.
Other risks include other liens on the property or a clouded title. While investing in tax liens can be very lucrative, be sure you fully understand the downside before handing over your investment money.
About the author: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.