Tax Lien Investing:
Everything You Wanted To Know About Tax Lien Purchases
By: Darius M. Barazandeh, Attorney at Law/M.B.A.
Tax
Lien Investing, tax lien riches, tax liens for wealth, tax lien
this, tax lien that...everywhere you turn there seems to be
someone selling information on tax liens. What most of these
'overnight' experts don't tell you is what could go wrong with
your investment if you fail to perform proper research. I have
helped thousands of investors make significant profits from tax
sales. I have seen the processes first hand in a number of
different scenarios: 1) as an investor, 2) as an attorney, 3) as
a business consultant to one of the largest tax collection
entities in the United States, and 4) as a teacher and creator
of the most advanced tax sale investment systems available
today. If you have questions then you are not alone. Tax sale
investing is an area that continues to fascinate investors. I
like to tell people, 'when you want to move past the fascination
phase...please look me up!'
Tax lien generalities can be found a 'dime a dozen' in
marketing-based products. Sadly, many of these products will
keep you wholly fascinated and perplexed with this investment
technique...especially since most will avoid the hard questions.
What are those negative aspects? What are those risks that don't
make it to the sales letter? If you want to learn the truth
about investing then hold off on the purchasing the $29.99 eBook
from the tax lien marketing guys...and spend a few minutes
reading this article
I. Introduction
Tax Lien and Tax Deed Investing: Everything You Wanted to Know
About Tax Lien Purchases
Earning 16% to 24% interest through a low risk and low
maintenance investment is rare to say the least. While some
investments in real estate or industry can match such high rates
of return, very few can equal the safe and passive cash flow
potential of property tax liens. Furthermore, tax lien
instruments are generally insulated from changes to Federal
Reserve interest rates. A further advantage is that the property
tax lien is secured to real property as a first priority claim.
The end result is a highly secured investment instrument that
can provide the investor with either: 1) a favorable return on
the money invested or 2) deeded rights to property. More
impressive may be the fact that tax liens can be purchased for
nominal amounts of money (e.g., under $200) or at larger sums
(e.g. $30,000 or more). The end result is a flexible but highly
secured investment with minimal downside and market risk. This
paper will discuss the tax lien process and the real risks and
benefits facing the investor.
II. Tax Liens vs. Tax Deeds: A Differing Approach
Tax liens or tax deeds are sold in 35 states. Almost every state
and territory, in the United States, has a process that is used
to collect delinquent property taxes and place reliable
taxpayers back on the tax role. This process occurs at the last
juncture of the tax collection process and it allows ordinary
individuals to purchase the rights of local governments in tax
delinquent property. The process can be separated between two
general types of systems: ‘tax lien systems’ and ‘tax deed
systems’. The tax lien and tax deed processes may be
distinguished by the ‘bundle of rights’ sold to the purchaser.
In states using a tax deed system, if the taxes are not paid,
county governments will sell full ownership and possession
rights to the investor. Currently 17 states authorize the sale
of ownership rights to tax delinquent property through a tax
deed sale or assignment deed. Conversely, in so-called ‘tax
lien’ states county governments sell only their right to the tax
lien or tax claim on the real property. A total of 18 states
have authorized sales of the counties’ tax lien position to the
public.
Tax Deed Processes
In a tax deed state the county will sell all of its rights to
the property at a public foreclosure auction or through a later
assignment process. The sale will generally occur 3 to 5 years
after the first tax payment becomes delinquent. Property is sold
for the back tax amount plus any fees, interest charges, and
court costs. Since property taxes are a small percentage of
market value, investors can acquire full property rights at a
fraction of the market price. The purchaser will generally
obtain full ownership rights or at least all rights held by the
county. In these states, the purchaser generally has the
customary rights of a landowner, namely to possess and/or occupy
the property.
Tax Lien Processes
In a tax lien state, counties do not sell property; rather they
sell their lien for unpaid property taxes. This lien is an
encumbrance or enforcement right held by the county. While the
lien does not grant full ownership rights to the property, it
does provide the investor with two commanding rights: 1) The
right to receive interest penalty charges if the lien is paid
off by the delinquent property owner, and 2) The right to
foreclose the tax lien and take title to the property if the
lien is not paid. Even better the property tax lien is a high
priority lien superior to judgment liens, mortgage liens, trust
deeds, and other private liens.
Because of the powerful nature of these rights, tax liens are a
very attractive investment opportunity. Moreover, since the
property tax lien is usually for a small fraction of the
properties’ market value the investment is highly secured. In
addition, the lien purchase does not subject the investor to
land owner liability since no right to possess or occupy the
property is granted by the sale of the lien.
III. The Tax Lien Process: A Tax Collection Effort
The 16% to 24% interest rates available to investors who
purchase tax lien certificates is a function of state law. In
other words, state law authorizes the substantial return awarded
to the investor.
History
Taxes based on property ownership can be traced back to
antiquity; however our modern system draws its roots from
fourteenth century England. Property ownership was first used as
a measure of one’s ability to pay the tariffs or taxes levied by
the English Crown. The tax later became assessed on the property
itself. [1] Property taxes were utilized in colonial America in
the early to mid 1600’s in order to fund local services such as
protection from Native Americans, European intruders, the
building of roads, schools, prisons and public relief. [2]
Late Taxes and Collection
Taxes tied to property are still used to fund many of these same
essential public services. The fundamental importance of these
services is the rationale for the high priority position of the
property tax lien. Almost uniformly, state legislatures have
given property tax liens seniority over judgment liens, mortgage
liens, trust deeds, and other private liens. This ensures that
money for public services is paid first no matter how many other
claims or charges are levied on a property.
In most states, property taxes are due several months after the
close of the calendar year. Some states divide payments into two
or three installments each becoming due at different times of
the year. While the process for collecting current taxes will
vary among tax lien states, late tax collection is generally
enforced in a uniform manner. If the property owner is late
paying their property taxes then the tax lien will remain
attached to the property until the taxes and penalties are paid
or the lien is foreclosed.
Tax liens held by the county against real property do not by
themselves provide the county with actual revenue (i.e., money)
for its operations. Until the delinquent tax dollars are
collected the lien is simply uncollected debt. Recall that since
local governments utilize property taxes to pay for needed
public services, collecting this tax debt is vitally important
for smooth running operations and budgeting.
During this time the county will notify the delinquent taxpayer
that their taxes are overdue. The county treasurer or tax
collector may also offer an extended payment plan at several
points in this process. Attempts to collect late taxes will
generally last between 1 to 1.5 years. Generally, after one year
of delinquency the county treasurer or tax collector will begin
to assemble tax sale listings for the upcoming year.
Tax Lien Sale: County Preparation Processes
The list of liens will include properties that have been
certified as delinquent for one year or more. Property owners,
participating in a delinquency payment plan, will not find a tax
lien to their property on the sale list. County officials are
required to notify the delinquent taxpayer of the upcoming lien
auction. These notice requirements generally demand that notice
of the upcoming sale be sent to the delinquent property owner
and be published in a designated newspaper for two to three
consecutive weeks before the sale. In almost all counties sale
listings are available 3 to 4 weeks before the upcoming sale.
Most counties have sale information online or can readily fax
sale lists to investors.
Tax Lien Sale Auction Format
Although variation exists among tax lien states, there are some
general similarities. First, all primary sales must be held in a
public auction format and ordinary citizens may take part in the
sale. Second, the starting price for the tax lien is made up of:
1) delinquent property taxes, 2) penalties, 3) assessments, and
4) other charges or fees.
While some variation exists among the bidding systems in tax
lien states, most can be categorized as follows:
1) Bid Up Process: Some states use a process in which the price
of the lien is bid up (i.e., increased) based on competition for
the lien. In this auction format the price paid for the lien may
be bid higher, but the interest rate earned by the tax lien is
fixed and will not fluctuate due to bidding. Examples of states
using this system are: Alabama , Georgia , Indiana , Montana ,
Kentucky and others.
2) Interest Bid Down: The second most common scenario is the
interest bid down system. During this auction format the
interest rate earned on the tax lien certificate is bid down.
The winning bidder is the person who accepts the lowest interest
rate payable on the lien. The price paid for the lien is fixed
and will not rise due to bidding. Examples of states using this
system are: Arizona, Florida, Maryland, New Jersey, Missouri and
others.
A few other unique bid systems exist in a small number of
states. No matter what type of bidding method used there are
numerous opportunities for the investor.
IV. The Tax Lien Investment: Redemption and Foreclosure
The tax lien investor earns profit in two scenarios: 1) if the
delinquent taxpayer or another lien holder pays off the late
taxes the investor will receive the principal paid for the lien
plus any interest which has accrued, or 2) if the late taxes are
not paid by a certain date after the sale, the tax lien investor
can foreclose and take title to the property.
Tax Lien Redemption and Interest Yield
In order for the delinquent taxpayer to save their rights to the
property they must pay the investor the amount of the back taxes
plus the interest rate stated on the tax lien certificate. This
process is called redemption. The delinquent taxpayer has a
limited amount of time to pay off the tax lien certificate and
its interest costs. This time frame depends on state law and can
range from 1 year to 3 years. This timeframe is called the
redemption period. Interest rates vary according to state law
but generally range from 12% to 24% per year. Interest accrues
based on the number of months the investor holds the
certificate.
Tax Lien Foreclosure and Large Profits
Perhaps the most powerful right of the tax lien holder is the
right to begin foreclosure proceedings. Foreclosure proceedings
should begin if the cost of the tax lien plus interest is not
paid off within the redemption period. Proper foreclosure grants
the tax lien investor full ownership rights in the parcel and
will eliminate the ownership rights of all other parties. If the
delinquent taxpayer redeems the certificate during the start of
the foreclosure proceedings, most state rules allow the investor
to tack or add the foreclosure costs to the redemption price.
Interestingly, since tax liens generally amount to less then 10%
of a properties’ market value, foreclosure creates a tremendous
profit windfall for the tax lien investor. For example: with
proper research, an investor foreclosing on $5,000 worth of tax
liens can acquire a property valued $55,000 or more. Thus, a
loan-to-value ratio of 10% is possible and seemingly unequaled
($5,000 + foreclosure costs / $55,000 = 10%). Many traditional
and creative forms of real estate investing can only create
loan-to-value ratios of 70% or more.
Tax Lien Article
Part 2 Tax
Lien Course
Texas Tax Deed Course
