My Take On Tax Liens

Tax liens have always been of interest to me. As a teen, I would remember the infomercials advertising tax lien investments as the way to own tons of property for pennies on the dollar. Since my father was a contractor and property manager, I was introduced to real estate ownership at a young age and read my first book on tax liens in my late teens. At the time, I could not figure out why more people were not investing in tax liens. As an adult, real estate professional and attorney, I can now appreciate the risks/reward trade off that comes with this asset class. So, here is my take on tax liens.

Tax liens are a low cost way to obtain exposure to the real estate market. Although the supply and demand of tax liens is very much influenced by local events, tax liens will be around as long as there are municipalities in need of money and property owners who do not pay their taxes. Although cheap and available, investments in tax liens propose some unique risks and benefits.

One of the unique benefits of tax liens is that they initially offer passive income at high rates of return. Most tax liens are purchased via auction and most auctions employ one of two bidding methods--bidding up price or bidding down interest. Whether the price of the lien is bid up or the interest rate is bid down, the amount of back taxes owed does not increase and statutory penalty rates of interest typically offer an attractive return to purchasers that do not overbid. Moreover, upon the purchase of a tax lien, the municipality continues to serve as the collection agency for a statutorily mandated length of time, in most cases. This allows investors to collect on the purchased lien with minimal effort, for a period of time.

Another benefit of tax liens is that they are a priority lien. This means that a tax lien has priority over even a first mortgage. This priority ensures that upon proper foreclosure, no other non-governmental creditors will have a claim to the property.

Yet another benefit of tax liens is that they are typically low cost. It is not infrequent to see tax liens be auctioned off at prices below $100 in most areas. It is also rare that annual taxes will exceed even 30% of the value of the property, therefore, exposure to a property can be gained for what would amount to a down payment in the context of an acquisition.

Despite these benefits, it is important to acknowledge the risks of tax liens. The first risk is that the procedures for purchasing tax liens vary greatly among municipalities. Not only do procedural formalities, such as publication time and location, method of registration, bidding procedures and payment procedures differ among municipalities, but the rights conveyed by the tax lien may also differ, based upon locations. Some localities sell tax liens with the eventual right to foreclose on the delinquent property, whereas other municipalities sell tax liens that only convey the right to collect the amount owed. These municipalities tend to have separate tax deed sales and auctions. A successful purchase at a tax lien auction requires knowledge of the procedures specific to the selling municipality. The same caution should be mentioned in regard to the timing deadlines for claiming the tax lien after purchase, collecting any proceeds paid on the lien and filing any necessary foreclosure actions.

Another risk of tax liens is that they are investments that must be "fed." If a tax lien is not satisfied by the property owner within the time required by law, the outstanding taxes that have accrued on the property will have to be paid prior to foreclosure, in order to insure that the foreclosed property is not subsequently foreclosed by the owner of later-purchased tax lien. As a result, a purchaser of a tax lien that expects to eventually own the property must also expect to pay the later occurring taxes. In many cases, legal fees for the foreclosure of the tax lien will apply, as well. Although most localities that require the filing of a court case to foreclose on a tax lien (judicial foreclosure) provide for an expedited process, none of these localities provide a cost free foreclosure process.

Purchasers of tax liens should be well informed of the parcel that is encumbered by the tax lien to avoid yet another risk of tax lien investing--insufficient due diligence. Many municipalities auction parcels with little or no economic value. Land-locked lots with no physical access or easement for access, parcels of land with a portion of a structure on them, or land deemed unbuildable are not desirable classes of property on which to own a tax lien. Additional issue such as zoning or use issues, building code violations and contamination are also matters to avoid, if at all possible. An investor in tax liens will have no right to address any of the aforementioned property issues until ownership of the property is subsequently obtained, increasing the likelihood that they will only mount further. Property condition and location should also be taken into consideration. Environmental restrictions on the land or location in a flood plain or earthquake zone should be noted.

If properly utilized, tax liens make a great performing addition to any real estate portfolio, however, knowledge and expertise is required in their acquisition. As with most real estate, buyer beware, as due diligence is very important. If done correctly, tax liens offer high performing real estate exposure and the ability to own property for a fraction of its market value.

Please tell me what you think by posting a comment below.