Tax Lien Certificates – Sure thing or risky business?
I have recently been made aware of tax lien certificates as a potential high interest bearing investment. A Wall Street Journal article (“Tax Sales Offer Chance to Profit On Misfortune” By Addie M. Rimmer) from 1986 demonstrates that I am quite behind the times on being introduced to this alternative investment.
So what are tax lien certificates?
Simply put, a tax lien certificate is a piece of paper from a county government stating that you have paid the taxes, penalties and interest on a piece of real estate with delinquent taxes due in that county AND that you have the right to collect interest on the amount you paid when the owner finally pays the tax amounts to the county. In case the owner neglects to pay their taxes within the state mandated period, the certificate gives the investor the right to collect on it via the underlying property.
Most of the time, the buyer or some interested party, will redeem the property prior to the time the tax lien holder could pursue a foreclosure.
How do they work?
Each of the 29 participating states can have different laws governing tax lien sales. Generally though, the following steps are involved:
The property owner does not pay real estate taxes. The county adds interest and penalty amounts to the taxes and puts a lien on the property. Note that this lien follows the property if it is sold and is senior to almost all other liens on the property.
Time passes and the county puts the property on a list to have it’s tax lien sold – so the county can get its money sooner than later. The county publishes the list of properties to be included in the tax lien sale (usually several times in a local paper and sometimes on a website). At this point a lot of owners come forward and pay their taxes!
The county sets an auction date (or dates) – this usually occurs on or around the same month and day each year. Investors register to bid in the auction and the auction date arrives. On the day of the auction, the investors bid on properties from the published list (the ones that are still available) and typically are required to pay immediately or very shortly after the sale. The county issues the investor a certificate and then more time passes.
Usually the owner will ante up the amounts due so they can retain the property. When they pay the amounts due (to their county tax office), the office sends a request to the investor for the certificate. Once the office gets the certificate from the investor, the office issues a check for the amount paid by the investor plus the interest earned during the period held.
When the owner does not ante up the payment, the investor gets the right to pursue ownership of the property. Processes vary by state on this. In some states, the investor is issued a deed right away, in others the investor must instigate foreclosure and eviction proceedings (if the property is occupied), in still others, the investor gets the right to bid on the property at the tax auction of that property.
So, by giving the county the amount of the back taxes, interest and penalties, investors can get a high rate of return on their money and have their investment secured by real estate – which can be obtained (sometimes for pennies on the dollar) if the owner of the property does not pay the taxes in a certain time frame.
Wow, you say, lets jump right in – 16% interest is way better than .25% that we get now on savings accounts!
Before we do that, though, lets look at what could go wrong:
Properties behind the tax lien may be worthless or hard to sell, for example:
- property that is held in common by multiple parties (such as a condo parking lot)
- property that is in violation of EPA regulations (you may spend a lot of money cleaning up something that is worthless)
- property that has been put into bankruptcy (you must take extra steps to preserve your seniority in getting paid out of the bankruptcy funds)
- property that is raw land and not able to be developed
- property where the improvements can disappear (like a mobile home that is part of the assessed value)
- business properties that don’t live up to their assessments because business is bad
- property that may be on a flood plain
- property that may not be zoned for the use it has.
Owners may not redeem their property:
- You would then probably have to pursue foreclosure, quiet title (legal action to make sure the title is good) and possibly eviction (would you have the strength to kick someone out of their home?).
- If successful in obtaining the property, you would have expenses you might not want such as taxes, insurance, legal fees, restoration, marketing and sales expenses.
The property is not worth the amount of the taxes, penalties and interest accumulated.
You would lack liquidity or you may unexpectedly get money back that you wanted to have invested – owners can re-pay at any time.
Do you buy tax lien certificates? I haven’t yet, but I will most likely sit in on the next one held in my county, just to see what the auction is like!
- The 16% Solution – How to Get High Interest Rates in a Low Interest World with Tax Lien Certificates by Joel S. Moskowitz, J.D., copyright 1994, published by Andrews and McMeel.
- http://www.tax-lien-investing-resource.com/tax-lien-investing-tips-and-risks.html“Tax Sales Offer Chance to Profit On Misfortune” By Addie M. Rimmer. Wall Street Journal [New York, N.Y] 08 Jan 1986: pp.