How Do I Improve My Tax Lien Chances?

Previously, we learned that tax liens still have a potential for loss, even though it’s better odds than the stock market.

So, what do you need to know to make a good tax lien certificate investment?

  • Learn how to research property.   County recorders are public records, so you can go down to your courthouse and look up real estate records yourself.  If you want to pay for the service, abstract companies can do it for you, but for a price.   Your objective is to look up the property that the lien is on, in order to determine if there are any other liens or anything else to cause a clouded title.
  • Enlist the help of a real estate lawyer.   If you have to foreclose, you’ll need their assistance.   The paperwork can be done manually by the lien owner, but a wrong turn can result in significant loss.  This, too, comes as the expense of investing.
  • Find a conservative estimate of the property’s value.  This can be done through past tax records, the auditor’s office, and sites like Zillow. Keep in mind things other than just a number on paper: is it in a good neighborhood? Does it flood every spring?  Is there any way to actually access the property from a road? Remember that, if the owner is going to let the property go at a tax foreclosure, there’s a good chance that something’s wrong with it.
  • Do the math:  add the cost of buying the tax lien certificate to the amount spent in filing and researching the property.  This is the total investment.  Now, calculate the amount that will be recouped if the property owner actually repays the taxes at the halfway mark before foreclosure and the amount at the end of foreclosure.  These are the potential returns.  Next, estimate the resale value of the property after foreclosure minus the cost of foreclosing.  This should give you a nice upward curve.  You want the possibility that, as the investment matures, the value keeps going up.

A few other notes:

  • There are investors that sell their tax lien certificates on eBay.  The question you should ask yourself is: “If this is such a great investment, why is it for sale on eBay, of all places?”
  • Advocates of tax lien sales often upsell the benefit of foreclosure at the end.  Remember, the previous owner couldn’t pay the taxes and couldn’t sell the property; will you be able to?
  • Buying tax liens from some county other than your own means figuring out how to research property, attend and bid at the lien sale, and possibly manage a foreclosure from wherever you currently live.  This is a significant investment in time and money, which must be factored in to your return calculations.
  • The laws regarding tax liens are varied and complicated; make sure you understand what you’re buying, and the loopholes of the local jurisdiction.  Can additional liens be sold for future years? What existing liens can be discharged at foreclosure?  What happens if a lienholder forecloses on the property before you collect any taxes?

There are certainly many ways to go about investing in tax liens, enough ways to fill hours upon hours of infomercial time with “systems” and “guaranteed investment” promises.   As with any investing, the only way to truly manage risk is to fully understand what you are buying as an investment.   Tax lien certificates are not risk-free, but they do have significant opportunities if those risks can be avoided and managed.  Do your research, and you might beat the odds.

How Does A Tax Lien Work?

Previously, we learned that tax lien certificates are used by counties to keep themselves funded, rather than waiting until after foreclosure to recover unpaid taxes.

There are two ways to buy a tax lien certificate:  from the government, or from an investor.   Buying tax lien certificates from a county is a matter of finding out when the sale is, researching the properties, and placing your bids.    If an investor is liquidating his tax lien portfolio for some reason, it can be transferred to a new owner in a private sale, while filing the appropriate transfer documents with the county.

Once you own the tax lien certificate, you learn a bunch of information:  what the owed tax is, what the interest rate is, and when the lien expires and a foreclosure may be done.    Each of those describes how an investor earns their return on their investment.

If a tax lien certificate is sold on Monday and the property owner pays off their taxes on Tuesday, the investor gets a check for the amount of the tax lien, the lien is removed from the property, and the investment has run its course.    If time passes before the taxes are paid by the property owner, interest grows on the unpaid taxes, and those are paid to the investor.

If a few years pass and the property is sold, the tax lien and any interest due is paid off the top, the lien is removed, and the investor recieved a sizeable return, usually about 10% annually.

If the tax lien reaches its time limit, then the holder of the tax lien certificate has a right to foreclose on the property, take ownership, and release the lien themselves.   Now the lienholder owns the taxed property – and since taxes due is usually a fraction of the appraised price of a piece of real estate they should own property more valuable than the lien was worth.

As an investment, this system seems to have no downside, as those late-night infomercials would have you believe.   Either you get the taxes, or you get the property.   What could go wrong?

Continue to Part 3: How A Tax Lien Investment Can Go Wrong

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.