Tax lien investing has long been a popular method of investing in real estate but it should not be taken lightly. Although potential returns are huge, so are the risks.
Approximately $425 billion in state and local real estate property taxes are owed across the U.S. each year. Of that, about $6 billion goes delinquent. In 28 states, Washington, D.C., Puerto Rico, and the U.S. Virgin Islands these delinquent taxes allowed to be sold to private investors. The reward to investors is the chance to collect the delinquent tax, a penalty, and interest. Depending on the state, the accumulative return on investment can range between 12% and 36%. If the taxes and penalties remain unpaid, the investor can potentially end up owning the property through foreclosure but regulations for this vary greatly from state to state.
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 stream from property taxes, many 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
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 can be serious cons to this...
The biggest risk when paying someone else's property taxes is the property owner could very well be going into or already be in bankruptcy. You might think that's no big deal since the property can be auctioned. However, people in bankruptcy typically also owe IRS taxes. The IRS will place its own 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 ends up with nothing and a loss on the back taxes he or she paid.
Also, consider why an owner might not being paying the property taxes. 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.
Tax liens are auctioned off. Reality is there is stiff competition for these liens. These auctions are handled differently in different states and counties. At some auctions, you bid the amount of taxes you're willing to pay and at others you bid down the interest rate you're willing to take. Any interest owed that you don't get, the county receives instead.
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. Tax lien investing can be very lucrative but you absolutely must understand the local regulations. Successful investors tend to specialize in specific states and counties or at least in states and counties with similar regulations.
Author bio: 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.