In This Article

  1. What are Tax Liens?
  2. What is Tax Lien Investing?
  3. Tax Lien Investing vs Tax Deeds Investing
  4. Tax Lien Investing Advantages
  5. Tax Liens Investing Disadvantages
  6. Tax Liens: Getting Started in 3 Steps
  7. 3 Tax Liens Investing Strategies
  8. Tax Liens FAQs
  9. Tax Liens: The Bottom Line

If you are a real estate investor considering diversifying your investment portfolio, there is an often overlooked real estate niche that provides excellent returns with a relatively low entry barrier.

We’re talking about tax liens. 

In this article, we will break down:

  • What tax liens are
  • The advantages and disadvantages of investing in tax liens
  • The difference between tax liens and tax deeds
  • Frequently asked questions associated with investing in tax liens

If you’re ready to learn whether or not investing in tax liens is right for your real estate business, let’s get started! 

What are Tax Liens?

First, let’s break down what tax liens are.

Tax liens are issued when a property owner does not pay the real estate taxes they owe to the municipality in which the building or piece of land is located. 

The property may not be sold or refinanced until the owners obtain a lien release once the taxes are paid off. 

In 28 states, towns and counties may issue a tax lien certificate allowing the certificate owner to claim the property until the taxes and any associated fees are paid off and sell it to the highest bidder. 

So how can you invest in tax liens?

What is Tax Lien Investing?

Tax lien investing consists of purchasing tax liens from the municipality to be paid back by the property owner. 

Lienholders can charge the property owner an interest rate and include any penalty fees or premiums in their repayment plan. 

Depending on the auction, the bids are based on the cash amount the municipality is willing to accept for the tax lien certificate (the highest bid wins) or on the interest rate the investor may charge the property owner (the lowest bid wins). 

If the property owners fail to do so by a set deadline, the tax lien holder can foreclose on the property. 

However, it is not the typical outcome for tax lien investing since most owners repay their debt in time. 

Tax Lien Investing vs Tax Deeds Investing

Both tax liens and tax deeds are consequences homeowners must face when property taxes go unpaid. However, unlike a tax lien, a tax deed transfers the title of the property itself and any rights attached to it to the buyer. Some states allow the property owner to pay back their delinquent property taxes and any fees and penalties to redeem their rights to the property.

Tax Lien Investing Advantages

Low Entry Barrier

Entrance barriers for tax lien investing are relatively low compared to other forms of real estate investments, which allows investors to diversify their portfolio to other forms of assets (commercial, industrial, residential, etc.) or other communities. In some cases, investors purchase the tax lien certificates for as low as a few hundred dollars. 

High Interest Rates

Tax lien investing also allows charging higher rates than other forms of investing. The maximum interest rate varies by state, but keep in mind that your returns will be lower if you bid on the interest rate at auction. 

Specific Returns

Finally, it is easier to get a clear idea of your returns with tax lien investing since you can calculate precisely how much you will receive from the property owner. 

Tax Liens Investing Disadvantages

Like any form of investing, tax lien investing is not without risks. 

Research & Education

Tax lien investing requires a significant amount of research and real estate knowledge from the investor to be profitable. 

For example, the property value needs to be significantly higher than the amount of tax due. If the market value is lower, the homeowner is unlikely to repay his debt. 

Therefore, the investor should do a thorough tax lien search before bidding. It should include:

  • the condition of the property
  • its location (possibility of environmental damage, for example)
  • and more

You should also be very familiar with the local rules regarding tax lien investing, communication with the property owner, and lien release in the municipality you are considering. 

Foreclosure Can Be Expensive

If the homeowner decides to default on the loan, the investor may recoup at least part of their costs by taking possession of the property. However, some states do not allow investors to start the foreclosure until a set date, and foreclosing is a lengthy and expensive process. 

Beware of the Expiration Date

Beware that tax lien certificates have an expiration date after the end of the redemption period. Once the date expires, you will no longer have rights on the property, and any investor can make a claim if subsequent liens were issued. 

Competition

With the increase in competition from larger companies, profitable tax lien investing has become more complex. 

Tax Liens: Getting Started in 3 Steps

Tax lien investing may seem complicated. Here is how to get started. 

Step 1: Understand Rules and Regulations 

The first step is to familiarize yourself with the rules and regulations in place regarding lien release, redemption period, how to communicate with the property owner, return rates, and the bidding process itself. 

Step 2: Find Tax Liens for Sale

Next, find tax liens for sale. This can be done through auctions offering tax liens for sale. It is best to begin your journey into tax lien investing in an area you are familiar with. 

However, keep in mind that not all states allow municipalities to offer tax liens for sale to investors. 

Your local tax revenue office can direct you towards the next auction and the requirements you must meet to participate. 

Step 3: Bid on Tax Liens

You can then bid on the tax liens. 

Again, keep in mind the number you are comfortable investing in, taking into account:

  • additional fees 
  • older liens
  • renovation costs 
  • and so on

If you are intimidated by the process or prefer a more passive approach to tax lien investing, you can look into organizations such as the National Tax Liens Association. 

3 Tax Liens Investing Strategies

Tax lien investing requires thorough research on the local rules and tax lien search. You should also have a strategy in place for the most profitable outcome. 

Tax Liens Investing Strategy #1: Buy and Hold

Buy and Hold can be an excellent strategy in areas with the highest interest rates, such as Florida or Iowa, which have an 18% and 24% maximum interest rate. 

Your profits will increase over time until you authorize the lien release once the property owners pay off their debt or you proceed to foreclosure. 

Tax Liens Investing Strategy #2: Foreclosure

If foreclosure is your goal, look into properties in states like Florida, which allows you to start a foreclosure procedure as soon as you become the lien holder. 

However, beware that there may be additional costs, such as older liens, that you may need to repay before obtaining rights to the title. 

Tax Liens Investing Strategy #3: Resell

Some states also allow you to resell your tax lien to another investor if you decide that tax lien investing is not for you or if you prefer to avoid getting your money tied up. 

Tax Liens FAQs

Here are some of the most frequently asked questions associated with tax liens. 

Q: Is buying tax liens profitable?

Tax liens can provide high returns for educated investors. 

However, it requires an excellent understanding of the local real estate market and the local laws and regulations regarding tax liens in the area you are considering since they vary widely. 

Q: What are the risks of buying tax liens?

Tax liens may not be profitable if the value of the tax lien is higher than the property's market value. 

There may also be hidden costs and expenses, such as older liens, that would need to be paid off to get ownership of the title. 

Q: How does purchasing a tax lien work?

Investors purchase tax liens municipalities issue against delinquent property taxes. 

The property owner must pay back the lienholder with interest within a set redemption time. 

If they fail to do so, the investor can foreclose on the property.  

Q: What percentage of tax liens are redeemed?

According to Brad Westover, executive director of the National Tax Lien Association, approximately 98% of property owners redeem the property before the foreclosure process starts. 

Tax Liens: The Bottom Line

Tax liens is one of the many real estate niches that can produce a profit, but it is not without risks. 

The best way to mitigate those risks is to grow in your real estate knowledge so that your next investment deal will be the most profitable one yet.