Tax Lien Certificates – Sure thing or Unknown Abyss?
Robert T. Kiyosaki (of Rich Dad Poor Dad) uses them like Certificate of Deposits. Steven Stone invested $804 on 6 properties for 18% interest in Florida. He says, “You always get your money back” according to Addie M. Rimmer in the Wall Street Journal. Joel S. Moskowitz, J.D. Says they are super safe, high interest rate, guaranteed and may result in an investor getting a piece of property super cheap.
So what are tax lien certificates?
Counties in the USA have the legal right to assess and collect real estate taxes on property held in their county. If the property owner doesn’t pay those taxes for a state specified length of time, participating states will sell the right to pay the taxes on the properties at a tax lien certificate auction.
Tax lien auctions are held by only some states – 29 according to Moskowitz in The 16% Solution. They are different than tax sale auctions in that the investor gets only the right to collect interest on the lien for the first few years. In a tax sale auction, the property is actually sold and no interest is collected by the investor.
The buyer of the right (the tax lien certificate buyer) is guaranteed a certain amount of interest (can be up to 50% in some states) on the taxes , penalties and interest they pay – if the owner redeems their property by paying all the taxes, penalties and interest. If the owner doesn’t redeem their property, the tax lien certificate holder may get the right to pursue a foreclosure to obtain the property (or the right to bid on the property at a tax auction in some states).
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 participating state can have different laws governing tax lien sales. Generally though, the following steps are involved:
- A property owner does not pay their 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.
- 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).
- Investors register to bid in the auction.
- The auction date arrives.
- Investors bid on and pay for any tax liens they win.
- The county issues the investor a certificate – after getting paid by the investor.
- Time passes.
- Usually the owner will ante up the amounts due so they can retain their 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.
Benefits of investing in tax lien certificates:
- High rates of return are possible (8%m 10%, 16%, 18% – it varies by state).
- Your investment is secured by a senior lien on real property – safe – as long as you don’t have to foreclose.
- You can buy liens of various different amounts – so you could start small if you want.
Risks of investing in tax lien certificates:
Properties behind the tax lien may be worthless or hard to sell – such as:
- property 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,
- or 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 and possibly eviction.
- 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 have a lack of liquidity or you may unexpectedly get money back that you wanted to have invested – owners can re-pay at any time.
How to invest in tax lien certificates.
Prepare and research.
- Find the state you want to invest in and review the laws of that state. Then find the county you want to invest in and get to know the county officials. This may allow you to get a list of the properties to be offered. Sometimes these are listed online as well.
- Talk to someone in the know about the property – get the local scoop.
- Research the property you want to bid on – what shape is it in, what zoning does it have, is it on par with others in the areas, etc.
- Understand where your tax lien would stand in relationship to other liens the property might have. The federal government can put liens on property that are senior to any others, without publishing or announcing!
At the auction:
- Find out when the auction will be held and register for it.
- Have your money ready in the format proscribed by the county you are bidding in.
- Stick around during breaks, lunch and after the auction ends – to snag any unsold properties.
- Go in with limits on what you will bid.
- Go in knowing which properties you want to bid.
- Beware of scams.
If you do win a certificate at the auction, track your certificates and properties behind them so you can know if they are going into bankruptcy (which you don’t want).
Collect your money from the county when the owner redeems OR foreclose on the property to get it for pennies on the dollar (hopefully).
- Start with your own state and county or a county nearby.
- Consider bidding in smaller and rural counties – to avoid competition.
- Look into counties that do online auctions such as https://www.weldtaxsale.com/
- Do as much research on the properties as you can without spending a lot of money.
- Stick with residential properties.
- Keep to properties where the assessed values is at least 75% in the improvements (as opposed to the land being more valuable).
- Buy smaller liens – there may be less competition and you can get comfortable with the concept without laying a lot of money on the line..
- Look for areas that have high owner redemption rates (unless you want to foreclose and get the property).
- Stay away from industrial and commercial properties – to reduce risks of EPA contaminated properties.
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.
“Tax Sales Offer Chance to Profit On Misfortune” By Addie M. Rimmer. Wall Street Journal [New York, N.Y] 08 Jan 1986: pp. 1.