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Tax Liens and Deeds: Should this investment strategy be part of your plan?

By Jordan Taylor

In most situations, tax liens are not good news for real estate investors; they can cloud titles and reduce profits. But tax liens are good when you want to buy tax lien certificates, because you are not investing in property but rather buying the rights of a taxing authority.

“Tax lien certificates are one of the most predictable, certain, and secure real estate-related investments available,” says Thomas J. Senatore, a trainer with Wealth Intelligence Academy. “You buy them from the government, you get paid by the government, and the local tax collector does all the work.” Senatore says you can earn anywhere from 12 to 24 percent interest the first year and as much as 24 to 50 percent in the second year, depending on individual state law, the bidding system, and the period of redemption. Those rates are part of state statutes. They are totally legal and can be changed only by the state legislature.

How do these opportunities get created? Cities and counties need a way to encourage people to pay their property taxes on time and penalize them when they don’t. These local jurisdictions also need a way to borrow the funds that haven’t been paid so they can continue to operate and pay their own expenses. They do this by selling tax liens or tax deeds. As an investor in tax liens and deeds, you are performing a valuable service by lending money to governments so they can pay employees and provide services.

What’s the difference?

A tax lien is basically a loan that can be turned into a deed if not repaid after a certain period of time. A tax deed is a deed (which is ownership) to the property that may or may not have a redemption period.

Tax liens and tax deeds are created when a property owner doesn’t pay his taxes. At a certain point dictated by law, after the taxes become delinquent, the particular governing taxing unit (usually the city or county) places a lien on the property. A certificate for that lien is sold to an investor for the amount of tax owed plus penalties and interest due at the time the certificate is sold.

Most of the time, the property owner will eventually pay the amount paid for the certificate plus additional interest to the county. The tax collector notifies the investor, who returns the certificate and collects those funds. If the taxes aren’t paid within the time set by the taxing jurisdiction (typically one to three years, but sometimes longer), the owner of the certificate gets the property.

When you buy a tax lien certificate, you’re essentially paying the delinquent taxes on a property and buying the rights to collect those taxes plus additional interest from the property owner. You aren’t foreclosing or forcing anyone out of their home. In fact, it’s unusual for property owners to forfeit their real estate for the taxes. If a property owner wants to sell, most buyers are going to insist that the tax lien be taken care of before they’ll do the deal, so you’ll get your money then. In the unlikely event that the buyer overlooks the tax lien, you’re protected because it stays attached to the property until paid.

How the process works

Tax lien certificates are usually sold at a public auction and the details of the bidding process vary by state. Most tax collectors provide complete information on how the process works in their jurisdiction. As with any type of auction, it’s a good idea to attend a few tax certificate auctions when you have no intention of bidding just for the experience.

For most people, the biggest challenge of investing in tax lien certificates is understanding the bidding systems, which aren’t like those of a general merchandise auction where you bid a dollar amount on a particular item. In a certificate auction, some states require that you bid the amount that is owed the government plus a surplus to acquire the certificate. In other states, your bid reduces the interest rate, and the bidder who is willing to accept the least return gets the certificate. In still other states, the highest bidder gets the certificate. It all boils down to simple arithmetic—you just need to understand how to do the calculations necessary to make a profitable bid in each state, and state laws will tell you that.

Don’t ask other bidders for advice and information—they may know less than you do but don’t want to admit it, or what they think they know may be wrong. Get facts from reliable sources, such as the state statutes, the printed material furnished by the taxing agency, and individuals recognized as experts who provide certified training programs.

Comments

thank you - great article

Where would i go to find out the laws in each state regarding tax lien certificates? In Oregon they do not sell the lien certificate until the property owners are 6 yrs in the rears, then the property is auctioned.

The best place to find out how the sale of tax lien certificates are handled in the taxing authority is the local jurisdiction, usually the county tax collector/appraiser. They should also be able to tell you what you need to know about the applicable laws.

Do these tax lien certificates and laws exist in Canada? If so, where can they be found?

The short answer to your question about tax liens in Canada is no.

The system in Canada for dealing with delinquent taxes is much different than in the U.S. This is a non-technical, non-official, very much abbreviated summary of how it works in Canada: The local government does not take action on delinquent property taxes until they haven’t been paid for three years. Then any entity with an interest in the property (such as the mortgage holder) gets a chance to pay the taxes and foreclose on the property. If no such entity takes action, then the opportunity becomes available to the public, and the entire process can take four years. In Toronto, for example, they see just one or two of these a year open up to an investor.

If you want to find out more about how tax liens work and how common they are in a particular area, the best thing to do is to contact the real estate section of your municipality.

How is yield calcuated on a tax certificate that is paid prior to the end of the year.

Vincent,

The interest is prorated based on the amount of time you hold the tax lien certificate. For example: let's say you purchased a tax lien certificate with an annualized interest rate of 18 percent and the homeowner paid the taxes back after six months. You would receive the amount you paid plus 9 percent, which is six months of interest.

the information were right on the money !! but the question is or when does the lien becomes maturity to be recorded has your or the lienholder property?

Michael,

We'd like to answer your question, but we're not sure what you're asking. Remember that the laws governing tax liens and deeds are set by the state and also vary by state.

If you could clarify your question, we'll be happy to answer it.

Are there any type of properties that one should stay away from when bidding for tax certs? How about properties to zero in on? In my area I have noticed prior certs with the interest as low as .25%. Could this be a way for the owner to protect his property by having an allie buy his cert?

The best rule to follow regarding property types is to never purchase a tax lien certificate on a property you wouldn't want to own. It's unusual for the tax certificate buyer to foreclose on the property, but it can happen, so be sure you can deal with owning the property if it comes down to that.

The owners do not set the rates; rates are set by the government. The best way for an owner to protect his property is to pay his taxes so that there is never a tax lien to be purchased.

Great article. Very informative. Can Canadians invest in U.S. tax lien certificates and/or tax deeds?

Sara,

Yes, Canadians can invest in U.S. tax lien certificates. The investor's citizenship is generally not an issue; what you have to do is follow the rules established by the particular tax collector in a given jurisdiction. Some require that you personally attend the auction, but many offer online auction opportunities.

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