Tax Lien Investing: Everything You Wanted To Know About Tax Lien Purchases
by Darius Barazandeh
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.
V. Tax Lien Holder Rights and Advantages
The purchaser at tax sale will receive a certificate of purchase or
(‘certificate’). Thus it is said that the purchaser holds a ‘tax lien
certificate’. The certificate is a document that illustrates the investor’s
ownership in the tax lien. A properly researched tax lien will award the
investor with numerous benefits and in most cases very few headaches. In
general, the tax lien investor has the following rights and advantages:
1) The Right to Collect Interest or Foreclose: The prudent investor will
earn profit on the lien certificate no matter the outcome. If the lien is paid
off by the delinquent property owner through redemption, then the investor can
generally expect to receive a double digit return on the original investment. On
the other hand, if redemption does not occur then the investor can foreclose on
the certificate. After foreclosure, the investor will obtain full ownership
rights to the parcel. Moreover, since property taxes are a small percentage of
market value, the investor stands to earn substantial profit on the transaction.
2) A High Priority Lien Holder Position: At the tax sale the investor
purchases a tax lien once held by the county. The priority position of the
property tax lien is not subordinated (or diminished) because a private party
now holds the lien. The investor holds the same rights once held by the county.
Because the lien occupies a first position on the land title, foreclosure of the
tax lien clears almost all other liens from the title. Foreclosure not only
places full property ownership in the hands of the investor, but it purges the
land title of other subordinate liens and debts. The end result is a property
interest that is generally ‘free and clear’ of other obligations on the title.
NOTE: Exceptions will be discussed in Section VI.
3) No Landowner Liability or Maintenance Responsibility: An often
forgotten benefit of tax lien investing is the passive nature of the investment.
Only one state grants the purchaser of a tax lien possession of the property. In
all other states, the investor does not obtain possession by purchasing the tax
lien. The investor is simply a super priority lien holder, but not a property
owner. Because the tax lien investor is not a possessor of property, there is no
landowner liability. This is clearly an advantage as lawsuits against property
owners/operators continue to rise. According to The Wall Street Journal (Feb
2003),
'Something as simple as paying a college kid to clean your gutters or giving
youngsters a few bucks to shovel the driveway could lead to a serious lawsuit.'
The lack of control over the property creates an asset protection feature for
the tax lien investor. NOTE: After foreclosure the tax lien investor will have
possession of the property.
4) Enforcement Rights Without Enforcement Duties: Another advantage is
that the tax lien investor need not demand payment or start collection efforts
to compel payment from the delinquent property owner. Although the lien is now
owned by a private investor the county will still handle enforcement of the lien
until foreclosure. Some states will actually handle the foreclosure process for
you. Irregardless, there is no contact with the delinquent taxpayer. Moreover,
in the redemption scenario most state tax offices handle the collection of
redemption money plus interest. The investor will receive notice that payment
has been made to the county. Most states will require the investor to mail back
the actual tax certificate in return for the funds invested plus interest.
5) The Right to Purchase Later Year Tax Liens: Liens sold at auction are
only for one year’s delinquent taxes. If the property owner defaults on next
year’s taxes then the investor has the right to privately acquire these taxes
with no competition. This can maximize investment performance depending on the
tax lien jurisdiction. It also reduces research time since the investor will
already be familiar with a particular parcel.
Clearly tax lien investing presents some very favorable advantages to the astute
investor. The numerous purchase opportunities and the high security/low risk
nature of tax liens make this an extremely attractive option to many active
forms of real estate, stock and bond market investment.
Tax Lien Sales and Post Sale Opportunities: The tax lien purchaser is
also favored by the surplus of tax lien instruments that are available for
purchase. For example, at the 2003 Maricopa County , Arizona tax sale 21,200
liens were available for sale but only 14,156 liens were sold. A total of 7,044
or approximately 33% of liens were made available for purchase after the tax
sale. In 2004, that percentage totaled 27% and was still within the historical
range of fluctuation. Although Arizona ’s Maricopa County is a very popular
destination for tax lien investors, literally thousands of liens are still
available for purchase after each sale. Such liens would still carry a full 16%
interest rate for the investor. While such a large inventory can create
confusion for the investor, a systematic process for eliminating liens can
transform this into a simple yet profitable exercise.
VI. Tax Lien Investor Risks
Tax lien investing does have numerous advantages, there are also risks and traps
for the unwary. As with any type of investment (real estate or otherwise)
technique and a proper understanding of the processes involved are critical. In
the following pages I will review the general risk areas which can plague
investors. A full discussion of these risks is beyond the scope of this short
review, nevertheless realize that virtually all of these risks can be easily
avoided using a logical research and selection strategy.
Failure to Research Property:
Viewing the Property:
Property research is important before purchasing any type of real estate. Tax
lien investment is no different. Since the real property gives the lien its
security and value, viewing the property is recommended. You may decide to view
a parcel yourself or use a 3rd party. Many investors, including myself, travel
to high interest states just to view property and purchase tax liens. Numerous
states have aerial photographs of real property located in the county. Clark
County in Nevada has aerial photographs of property, as do many counties in
Florida and other states. In addition, realtors and other real estate
professionals have been used for years by the out-of-state investor when a
property sight evaluation is required. In fact, I have developed detailed
selection criteria for investors who plan on viewing the property and those who
do not. Applying these steps in their precise order is fundamental for success
in this process. NOTE: Someone should view the property.
Researching Value
:
The failure to accurately determine market value of property backing a tax lien
certificate is an unnecessary risk. County appraisal data is available online
for almost 70% of counties in the United States . Even more exciting is the fact
that this number will only continue to rise. Counties without online data are
just a phone call away. Of course, there are other components to market value
such as location, future uses, zoning, flood plain paths, city restrictions,
etc. The vast majority of these questions can be answered by viewing the
property, speaking to county employees, and/or contacting real estate
professionals in the area. The appropriate zoning department in that county can
also provide you with a great deal of information on any zoning regulations that
may impact the use of the property.
Environmental Risk:
The tax lien purchaser is not an owner of property for environmental liability
purposes. This is good news. ‘What about investors who foreclose on their tax
lien?’, you may ask. Well, Federal law has exempted lien holders who foreclose
on contaminated property allowing them to maintain lien holder status and avoid
liability. These rules are always subject to change so perform a few basic steps
before buying. First, a phone call to the state environmental agency is a
worthwhile step for the beginner. The investor is also better served by focusing
on subdivision lots and/or houses. The likelihood of environmental liability
with such ‘subdivision’ properties is greatly diminished and the property has
quicker re-sale potential. When working a new county an understanding of the
geographic area is worthwhile. In summary, environmental risk exposure when
investing is tax lien certificates is less than that found in other forms of
real estate investment. Remember that no possession generally means no landowner
liability in most states.
Failure to Research Title:
Surviving Liens and Encumbrances:
Property tax liens are superior to judgment liens, mortgage liens, trust deeds,
and other private liens. Nevertheless, some liens share equal priority with the
tax lien. For example, state tax liens share equal priority with property tax
liens in most states. Federal tax liens for unpaid Federal income taxes will
also share priority, thus survive the foreclosure of the tax lien. The investor
is unlikely to be responsible for payment since the Federal government has its
own ‘right to redeem’ which last 120 days after the foreclosure of the tax lien.
The investor is entitled to receive attorney’s fees, interest, and costs
incurred in the upkeep of the property.
Keep in mind however, that no investor should have to contend with state or
federal tax liens since simple research can quickly detect such liens. Where do
you find this information? I teach my students the often ‘hidden’ traps
associated with researching title. It is imperative that you get good
instruction when proceeding forward. Your goal should be investment certainty
through a streamlined research process, not confusion from erratic methods. I
have found that almost every ‘guru’ in this field tends to gloss over the ‘equal
priority’ lien issue. Never invest in tax liens without fully understanding this
area. If you have questions then please email me.
Bankruptcy of the Delinquent Taxpayer
Tax lien jurisdictions work diligently to exclude liens from the sale that have
pending litigation such as bankruptcy. Bankruptcy after the purchase of a lien
however can create some risk for the investor. If a bankruptcy occurs after the
tax lien purchase, don’t despair since all is not lost. The tax lien holder is
customarily given high priority when the debts of the bankrupt estate are paid.
Very seldom is the tax lien not paid off during a bankruptcy proceeding. The end
result is a favorable rate of return for the investor.
The only troubling scenario may occur in a Chapter 7 bankruptcy. Bankruptcy laws
may allow the trustee to pay the expenses of administering the bankrupt estate
before paying the tax lien. This is an uncommon practice and would require
sufficient grounds, namely that the tax lien debt is so high that payment would
make it nearly impossible to administer the bankruptcy. This is a difficult
position for the bankruptcy trustee to win. Also if the investor follows certain
cost guidelines when selecting a lien this risk can be virtually eliminated. In
the end, even bankruptcy can have little effect on a tax lien investment if
proper techniques are applied.
FDIC Held Liens
When a bank fails due to insolvency (i.e., not enough money) any loans owed to
the bank are administered by the Federal Deposit Insurance Corporation (FDIC).
If a loan administered by the FDIC is attached to a property on your list, then
move on. FDIC liens can create issues during foreclosure, namely delays. The
good news is that it is very easy to check for FDIC administered loans during a
review of title. In fact, a list of FDIC institutions is available online. Feel
free to email me for listings of FDIC controlled loans. Once you obtain the list
you should check the FDIC list against mortgage holders (if any) on the
property. Moreover since most tax lien certificates are redeemed, the risk of a
delayed foreclosure due to a FDIC administered lien is quite remote and easily
avoidable.
Foreclosure Title Issues
Title Certification vs. Suit to Quiet Title:
At one time obtaining ‘clear’ title through tax foreclosure sale required a
title clearing suit before the land could be sold with bank financing. Those
days are quickly coming to an end with the advent of title certification
processes. A title certification is a relatively simple and inexpensive process
that confirms title to lenders. This creates numerous opportunities to sell the
property with bank financing. Irregardless, some investors will choose to sell
the property to another investor using non-traditional means, such as a below
market value price (i.e., wholesaling). Depending on preference investors may
also wish to rent out or owner finance properties. Appreciation and interest on
owner carried financing can parlay a small tax lien investment into a cash flow
vehicle demonstrating astronomical returns.
Variations in State Procedure
Understanding Differing State Procedures:
A firm analysis and understanding of the laws in your investment state is
critical. There are many slight variations to the general rules discussed in
this paper. The good news is that proper information and training can bridge the
experience gap very quickly. I am committed to sharing my knowledge with you and
providing current, realistic information to new and experienced investors alike.
VI. Tax Lien Investor Preferences
While some risks do exist with tax lien investing, these risks can be avoided by
conducting simple research. Proper and systematic research techniques will award
the tax lien investor with numerous benefits and in most cases very few
headaches. Recall that tax liens can provide the investor with a safe and secure
rate of return that outperforms many other passive investment vehicles, such as
stock and bond market investments.
The low maintenance aspect of tax lien investing makes this a viable option to
many active forms of real estate investment. Investors who do not wish become
full-time property managers or who desire a passive, high yield, part-time
investment will delight in tax lien opportunities. Investors with substantial
capital can also utilize the tax lien sale process to quickly increase cash
reserves. Full-time investors who desire property ownership can also take
advantage of liens which have expired redemption periods. These liens are
available in every tax lien state.
Tax lien investing will also allow some control over the end results. Rules can
be manipulated depending on whether the desired end result is property ownership
or a stated rate of return, for example:
Property Ownership Strategies:
Recall that the prudent investor will earn profit on the lien certificate no
matter the outcome. An investor can greatly increase the likelihood of obtaining
the property by targeting out-of-town owners and vacant lands. Houses and
subdivision lots which do not have mortgages attached to the property are also
redeemed less frequently.
Redemption Strategies:
Conversely, an investor interested in redemption would target owner occupied
properties with attached mortgages. The more an investor utilizes these
processes the more the predictable the outcomes.
VII. Conclusion
Careful investing in tax lien certificates will allow for safe and quick wealth
accumulation. Recall that this investment technique combines tremendous upside
potential with very manageable risk. A recap of these advantages include:
- The Right to Collect Interest or Take Title to Property
- A High Priority Lien Holder Position
- No Landowner Liability or Maintenance Responsibility
- Enforcement Rights Without Enforcement Duties
- The Right to Purchase Later Year Tax Liens
In summary, perhaps the most exciting component of this investment technique is
the fact that it can be repeated time and time again with consistent results.
This is because the same legal processes create consistent opportunities year
after year resulting in a steady inventory of tax liens. You can feel good about
your efforts since your investment will help local governments fund important
civil services.
Keep in mind however that the rules forming the process are subject to slight
variation as time passes so keeping up with changes in the law is important. Tax
lien investing is a significant opportunity which also requires some specialized
knowledge. If you can ‘learn the ropes’ so to speak, then it’s very easy to
multiply your money hundreds of times over. Here is my suggestion: 1) learn the
process, and then 2) repeat the process until you are satisfied with you wealth!
Bio:
The author, Darius M. Barazandeh, Esq. is a licensed attorney in the state of
Texas. In addition to his legal knowledge he has a Masters Degree (M.B.A.) in
Business Finance and brings experience from numerous fields including tax sale
investing, real estate construction, corporate finance, and business consulting.
Frustrated by the lack of realistic information regarding tax foreclosure sales
and other investments, he is "unlocking the secrets" to many of these creative
investment methods with his unique 'clear cut' writing style, attention to
detail, and legal knowledge.
Information contained within this article was not intended to be, nor should it
be taken by the reader as legal, financial or tax advice. The above article was
written for educational purposes only. If the services of a Texas attorney, or
real estate mentor or coach are desired, please contact Darius Barazandeh or
seek the services of another professional.