Nathan Nycum
California State University, Fresno
Tax Lien Investing
There are quite literally hundreds of ways to invest in real
estate. Each method and strategy has its own advantages and disadvantages. In
this depressed real estate market a unique type of investing has grown to a
level that is not normally seen. Tax lien and tax deed investing can prove to
be a very lucrative form of real estate investing with a relatively low level
of risk for those who know how to do it. This paper will summarize what tax
liens and deeds are and how they work, analyze some of the risks and benefits
of investing, and discuss some current techniques and strategies that investors
are using.
What are Tax Liens and Deeds?
The use of tax liens and deeds varies widely from state to
state and each state sets its own procedures and laws to handle their tax
policy. A tax lien is a claim attached to a property that gives the lien holder
the right to collect the money owed plus interest by foreclosure if necessary.
A tax deed is very similar but differs in that it gives the party holding the tax
deed the right to take ownership of the property immediately. Tax liens and
deeds occur when a property owner fails to pay all or part of their property
taxes. When this happens the county places a lien on the property and holds it
until the annual public auction. Most of the liens are sold to investors at
these auctions but those that aren’t get placed in the county’s inventory and
held until the next year if still unpaid. Once an investor purchases a lien
they own the right to collect the delinquent taxes owed plus all the penalties
established by the county. If the delinquent taxes remain unpaid until the end
of the period allowed (5 years in California) then the lien holder can
foreclose and take ownership of the property. The other possibility is that the
delinquent taxes are paid including all interest and the investor makes the
return stated on the lien they purchased.
Benefits and risks of Investing
Even though
there are numerous laws that usually ensure that the investor’s return is
guaranteed, this type of investing is not riskless. Since a tax lien is a sign
that someone is not paying their bills there is a strong likelihood that other
liens exist on the property in question such as judgment liens or IRS liens. In
most cases the tax lien takes priority over all other liens or encumbrances but
some in states or counties this is not true. It is completely up to the
investor to research the property thoroughly and often in order to mitigate
their losses and avoid risk. In addition, many states and counties have payback
periods that last for several years so most tax lien investments are long term
investments. On the other hand there are several benefits to the tax lien
investor. The returns are fairly high as most states charge around 18% which
all goes to the investor if repaid. It is also a way that some investors build
their portfolio through the foreclosure process to earn even higher returns by receiving
the properties debt free.
Techniques and strategies
Within the
area of tax lien investing there are many different techniques and strategies
and since each state and county have different rules it works well for many
different types of investors. The most common way to buy a lien is to
physically go to an annual auction and purchase the liens available. This can
be very difficult for a lot of people since there is a lot of competition at
the auctions which means that the returns usually go down depending on the
bidding system used. Additionally, it can be difficult for some people to
travel to each of the counties they want to invest in. In order to avoid so
much competition some investors choose to target specific properties that they
have researched to be great investments. Others have found ways around the
auction process entirely by going after over the counter (OTC) liens. An OTC
lien is one that has been placed into the county’s inventory after the auction.
Some counties allow investors to simply purchase the liens directly without
having to wait for the annual auction. Some investors simply want the stated
return and don’t want to bother with the foreclosure process and others invest
strictly for that purpose. In order to increase the likelihood of a foreclosure
and shorten the payback period these investors will target mature liens which
are liens that are close to the end of their redemption period.
To the new investor; the concept of what a tax lien is and
how it works can be quite complicated. But to the seasoned and knowledgeable
investor tax liens provide a very unique type of investing that can produce high
returns with fairly low risk.
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