What Are Tax Lien Certificates?

When I got up this morning, the TV was on and an infomercial for guaranteed tax-lien returns was on the History Channel.   As you’d expect from an infomercial, it followed the same method of sales as the Carlton Sheets ads did – show people who got rich using the system, have the charismatic originator of the system talk about how awesome it is, and throw around hyperbole about getting rich and guaranteed results.    The thing is, tax lien certificates aren’t a secret, nor do they take a super-complex system to work.  They aren’t, however, guaranteed nor a safe bet.

So, what is a tax lien?   Well, when you owe taxes to your city, county, state, or nation, and you don’t pay them back fast enough, the government places a lien on your property.  If the lien is on a home you own, the paperwork is filed with the county recorder’s office, like a mortgage or a contractor’s lien.    Now, the owed taxes are top of the list to be paid back when the property is sold, or foreclosed on, and it generally eats up your equity if you thought you’d get another loan on your property.  If you continue to not pay your taxes, interest and fees build, and the lien gets bigger.

From a business standpoint, unpaid taxes are the accounts receivable of a county’s budget.   If you ran a business where people who owed you money never paid, and your outstanding AR balance sheet kept getting bigger, you’d have to take action.  Businesses turn things over to collection agencies who call you during dinner and leave terse messages on your work voicemail.  Governments can’t really do that, not with as much leeway for collecting.   They can get a lien against personal property, they can sieze accounts and tax returns, but beyond that, foreclosure is a pretty big step for a county to get into.

A lot of counties do go the foreclosure route, and have an annual tax sale.    If you ask your county auditor’s office around October what properties are up for sale, they’ll probably have a list for you.  Properties usually have a starting price above the owed taxes, and are sold in an open auction, so the actual sale price might be quite high.

The downside of a county holding on to tax-default property is that they still don’t have their money.   If the property doesn’t even sell for the owed taxes, the county is stuck.   These end up as ‘counter sales’, unwanted properties that anyone can step up and buy for a low price.   Getting to that point means the county has to wait on getting the tax revenues for years and years, affecting budgets and services.

A few states have moved to the tax lien certificate sale in order to improve tax revenue cash flow.   When taxes go unpaid for a few years, the lien is placed and put up for sale.   Interested parties who’d like the chance to collect the state’s fees and interest, or the opportunity to foreclose on the property themselves, can pay the county the back taxes and some filing fees, and become the holder of interest for the past-due taxes.   This way, the county doesn’t have to wait for tax funds until they foreclose and sell the property themselves.

In a sense, the past-due taxes are “borrowed” from a private investor, and the investor is either paid back when the taxes are caught up or the investor gets to foreclose and own the property themselves.  The county or state passes on what little risk they had to investors, who can potentially profit on the deal.  The county keeps money flowing, investors get a chance to profit, and everyone’s happy, right?

Next - Part 2:  “How Does A Tax Lien Work?”

Small print: tax lien and tax sale laws work differently in different states and counties.  General information here is not intended to encompass all possibilities.  Consult local laws before investing in tax liens or tax certificates.