Tax Lien Investing: Double-Digit Returns – But Is This Investment Right for You?

Daniel Penzing
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Property Tax Basics

Prior to the 1980s, the government’s main source of revenue was from property taxes. Today, however, most funding comes from income taxes and sales taxes. Property taxes are still important sources of funding for state and local governments, though. In some parts of the country, especially rural areas, that income stream remains vital for governmental services. In every state, property taxes are assessed and collected by local governments (counties, cities, boroughs, villages, and townships).

In some states, certain districts can levy add-on taxes – these can be used for school buildings, emergency services, fire protection or other things. In a handful of states, localities can only levy add-on taxes with the approval of their voters.

The value of the property is the tax base. Just about every home is taxable. Even though a house may be located in a wealthy neighborhood, there’s a chance that the lot is relatively small and the house is old and not worth much.

A new home in a nice neighborhood may not have as high a value as its neighbors’ homes do. Realtors and buyers like to see the property’s tax assessment because it gives you a general idea about how much the property is worth.

What Exactly Is a Tax Lien Certificate?

While this could become an in-depth topic, the basic answer is that tax liens are promissory notes that are issued by the municipality to pay back taxes to the investor. You might be surprised how many municipalities in the United States rely on tax lien certificates to pay for public services. For instance, parts of the state of Pennsylvania use this method for public improvements.

Another common use of this method is in probate situations when an heir is given a year to pay the estate taxes and does not pay. These liens can become very lucrative if they are not paid off, which is why they hold value even after they are paid off.

However, this form of investing is definitely not for everyone. Before you jump in and start investing in tax liens, there are a few things you need to know.

The Ease of Investing in Tax Liens

There are no origination fees, and your investments come with an obvious, guaranteed return. Purchasing real estate as an investment is always a risk, since there is no guarantee that you will be able to rent the property for enough to cover the loan and still make a profit.

With tax liens, there is no such risk of a property losing value. Lien holder gets paid when the property sells, in most cases. Therefore, you are guaranteed you make money on the property sale.

A lot of dependability.

The (Big) Benefits of Tax Lien Certificate Investing

Tax lien certificates are a great way to invest because they provide a double-digit return on investment while backing it up with hard assets. A properly researched tax lien certificate investment is a solid investment that can provide customers with a good risk-adjusted return.

Why Tax Lien Certificates?

Tax lien certificates – also known as real estate tax certificates – are a simple asset-backed investment with a high rate of return. Here’s an outline of the process:

Your client obtains the tax lien certificate and only has to pay the delinquent property taxes (or other fees on the certificate) and the attorney fee.

If the delinquent taxes and fees are paid within six months of the original due date, the investor gets his original investment back, plus interest.

The investor also receives title as owner of the property. After one year, your client can foreclose on the property (which can net a large profit), or they can sell it.

Investing in tax lien certificates is an excellent way to provide your clients with a good return on investment while they’re waiting for the property to be sold.

Your Clients' Options

There are different avenues your clients can take:

They can work out an arrangement with the owner on a future sale of the property.

There’s No Limit on How Much You Can Invest

You might be a bit wary of this one. Investing in a tax lien can be a great way to make some money, but there are some drawbacks. And before you get excited at the thought of double-digit returns, keep in mind that you’ll be investing in an asset that could be quite hard to get back. And if you’re not careful, you could well find yourself losing a lot of money.

On the other hand, if you know what you’re doing – and are careful – tax lien investing can be an incredible way to make even more than double-digit returns.

So how can you make the most of a tax lien? For starters, you have to know a bit about how they work.

A tax lien is an assessment created by the Internal Revenue Service (IRS). The lien will show up on your property’s title.

If you do not pay your taxes, then the IRS can use this lien to get the money it’s owed. This is how the IRS can seize your assets and try to collect taxes from you through a tax sale.

How to Bid

The purchase of tax lien certificates can be a good investment. Many states and municipalities, who are in need of additional operating funds, allow these tax liens to be purchased by investors at tax sale, and then liquidated once the liens have matured.

You want to know that you’re getting a good interest rate for your money. By doing some research on the interest rate and number of years until the lien matures, then you can establish how much you can potentially earn on your investment. Make sure you find out what the current interest rate is for the securities (typically at least 8-10% interest at this time).

You want to make sure you are bidding on the right tax lien certificates for your portfolio goals. Different states offer different terms for the certificates. You can bid on the certificate with the lowest interest rate, or you can gauge the risk (even at a higher interest rate) and bet on the riskiest tax liens. The safest wager is on the ones that will yield the highest return.

So How Does It Work?

Tax lien investing is fairly easy. It involves buying certain types of tax liens.

Tax liens are a sort of security on a property. They are created when the government files a lien on a property to collect unpaid taxes.

When the government files a lien on a property, the lien amasses interest until it is removed.

If the owner of the property fails to pay the taxes or redeem the property, the government will take over the property and convert it to its use until that amount is paid.

Since property owners are always at risk of tax liens, some owners will pay taxes early, and lenders may snatch them up.

This way forward has not been baked up and is free from risks. Lenders will first file a lien on the property and pay some amount of money to the owner of the property on every installment.

Liens get removed on a fixed date. If the tax isn’t paid before this due date, the lender will transfer the lien into a title document.

What this means is that the lender will hold the title of the property until the debt is paid off. If the debt is paid off, the lien is removed.

The interest rate is adjusted to the prevailing rates, the same as other loans.

The interest on the security is usually a very low amount and not a very high one.

Make Sure to Do Your Due Diligence

It can be easy to get caught up in the hype around tax liens. Every new investor, local business, and public official who hears about the returns murmurs the same refrain: "At those returns, who wouldn’t want to invest?".

But graduating students and recent retirees are not the only people affected by tax liens. There are countless American households who have all of their savings tied up in one house. There are also retirees who have already lived out their lives to the fullest. Making them work well into their retirement can be problematic.

Buying tax liens can be great if you have a healthy nest egg and want to diversify your investment portfolio. But bear in mind that tax liens can be stripped out from under you if the underlying property is sold.

Learn More

Short sale investing is an investment strategy that allows you to buy property at a huge discount. It involves buying property at a price that is more than 60% discounted to its market value. This type of investment is also called distressed property investing, an investment that allows you to offload properties for pennies on the dollar. Short sale investing is not for the faint of heart; however, if you are willing to invest in distressed or illiquid properties that have outstanding loans, then this is an excellent investment opportunity.