Tax Lien Investing: What Are They and Why Do We Have Them

Tax Lien Investing as an investment strategy may quite possibly be one of the best kept secrets in the business. It is not that the information is not available. I believe it’s because there tends to be a negative connotation around any investment that has to do with government involvement and the fact that people may have lost their home. So the majority of investors have looked away from this investment strategy. Tax Lien Investing: What Are They and Why Do We Have ThemTax Lien Investing is for the person looking to make a great solid return on their investment, similar to what cash flow would be on a turnkey cash flow property. This investment is strictly a return on investment type of investment, but one that is very lucrative.

Real estate investors looking to get into tax lien investing ultimately want to look deeper into tax deed investing. I do suggest reading and understand this post on tax lien investing as a prelude to tax deed investing to get the best understanding of the two and how they differ. So let’s identify exactly what is a tax lien and why they exist.

First of all why tax liens exist:

Each city or municipality has expenses to run their city. Things like fire departments and police departments and schools and school buses and drivers for these school buses, etc. The money needed to run these services comes from a variety of sources that are essentially tax dollars.

One of these tax sources is property tax. To continue to run these services everyday, it is imperative the money comes in regularly without fail. When someone does not pay their scheduled tax bill, this makes it impossible for the local municipalities and cities to pay their expenses and continue with the services they must provide.

Understand that in a non-perfect world there will be, from time to time, people who cannot or will not pay their scheduled tax payment. The city and municipalities had to create a safe haven to make sure they did not have a short fall in their income stream when these tax payments were missed, so they introduced the tax lien. When taxes are not paid, the city still needs to collect the revenue to maintain its services so they sell the tax deed certificates.

What is a Tax Lien (tax lien certificate?)

When someone misses a property tax payment, the city will sell a tax certificate for that property. The process, prices and fees vary by county and state, but here is a general idea of how they work...

There is a missed property tax of let’s say $1,000.00 for the property at 123 ABC Street. The city sells tax lien certificates where you can buy this certificate for the $1,000. With a guaranteed rate of return (again varies by area but 18 percent is a good average and often higher), so lets use 18 percent in this example. You now own the tax certificate for 123 ABC Street for $1000. The owner of this property has typically two years to go to the city to redeem this certificate (called the redemption period).They must go pay the city the $1,000, plus the 18% interest rate, plus any additional fees required by the city. Owners of property are very motivated to redeem these certificates because if they do not redeem them in the time allowed, they may risk losing the entire house to the owner of the tax lien. The owner of the tax lien essentially has the house as collateral insuring a safe investment.

This was a simple example. This would play out like the example if there was only one person who wanted to purchase this tax lien, however because of the incredible returns there may be more than one person looking to purchase the tax lien. If indeed there is more than one buyer, they may use a bidding process to essentially sell this to the person who wanted to pay the most. Example: someone may opt to pay $1,100 for this tax lien because the returns are so great.

Because there are often a number of different tax liens being sold at once, competing for a tax lien does not often exist, but that is the process if there are competing bids.

What happens if the tax lien does not redeem and the redemption period ends without payment by the owner?

Free Real Estate Investing Planning WorksheetWhen you are strategic in your purchase, the odds of this happening are very slim. When it does occur, you (at the end of the redemption period) can start foreclosure proceedings and take possession of the house. Because taxes are always the first lien position on a home, (the lender) if any comes in second. The lender will not want to lose the house to a small tax lien so they will most likely redeem the certificate so that they do not lose their equity position in the house. Should this not happen, depending on city and state rules, you have the right to foreclose on the property and take possession of the home.

States and counties dictate the rules for the process and they change by location. Some states are called tax deed states. This is where it gets interesting.

See next post: Tax Deed Investing...