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Investing in Tax Lien Certificates and Tax Deeds

Last week I sat down with my husband Paul after reading Rich Dad, Poor Dad [1]. My mind was racing with ideas, as I am sure yours were if you have read the book, and I decided to delve into these ideas by first looking at the topic of tax lien certificates.

Admittedly when I sat down to talk about this with Paul, I knew hardly anything about them, except that they could bring in 16% interest (a far cry from the 0.02%-2.5% savings accounts are earning now [2]), and they are issued because of homeowners that have not paid their property taxes. Paul was intrigued as well, and we decided to research this investing option. Below is what we learned.

Tax Deed Vs. Tax Lien States

People own property, and become delinquent on their property taxes. State and local governments depend upon these taxes to fund programs, and so they have come up with ways to satisfy this budget leak [3] and collect on their taxes.

About half of states are Tax Deed states, and the other half are Tax Lien States, which refer to the method the government uses to collect delinquent taxes. In Tax Deed states [4] governments actually sell the deed to the property at auction to investors in order to recoup their costs. In a Tax Lien state, the government sells a Tax Lien Certificate, and pays the investor interest until the tax lien certificate is redeemed. Of course there are a few hybrid states, such as Texas and Georgia that sell the property at a tax deed sale, yet allow the owner a redemption period to pay off the lien and reclaim the property. And New York, Florida, and Ohio have both tax liens and tax deed sales.

What a Tax Lien Certificate Is

According to Wikipedia, a Tax Lien [5] is a lien imposed by law upon a property to secure the payment of taxes. While a tax lien may be imposed for delinquent taxes owed on real property or personal property, or as a result of failure to pay income taxes or other taxes (generally referred to as an IRS lien), for this article we are concerned with just the real estate property taxes.

When a property owner becomes delinquent on his/her taxes, a tax lien certificate is issued by state governments in the amount of the taxes due, any interest due, plus any additional costs, and is sold to investors in order for the government to recoup its costs. As an owner of the tax lien certificate, you own a note on the property for a specified redemption period, and earn interest for each month the note remains outstanding. At the end of the redemption period if the taxes are not paid to the investor, then the investor has the right to initiate a tax lien sale and tax lien foreclosure proceedings.

How to Purchase a Tax Lien Certificate

In tax lien states, the delinquent taxes, accrued interest, and costs associated with the sale is put into a lien certificate and sold at public auction to investors. Auctions can be either in person, or over the internet, such as on eBay [6]. Actual procedures vary from state to state, and may be conducted at a courthouse, or a private law firm. It is best to research online for your state and county to find out how to conduct a lien search, or if you want to speak with someone in person, call your county tax office. Also, be aware that payment is often necessary at the auction, in cash, or within two days. Check out this article on some tips for the auction process [7].

How Long is the Investment Period

Redemption periods, or the time period the owner has to pay their taxes, can be from 120 days to 3 years, depending upon which state you purchase them from and if the lien results in a tax foreclosure. Each tax lien certificate has a redemption period that the investor must wait before he/she can contact the homeowners.

How Much Can You Earn

tax lien certificates have a fixed rate of return, which could be anywhere between 16%-50%, again depending upon which state you purchase them from.

There are a couple of scenarios that would equal different payout amounts to you. Let’s say the property owner pays the government the outstanding taxes due before the certificate reaches maturity (and before the redemption period is up). When this occurs, then the government will send you your initial investment along with all outstanding interest due.

If the owner does not pay his/her tax obligation, then the government will give you the deed to the property. That’s right; you will have purchased a home for a ridiculously low cost. In some cases you will have to initiate foreclosure proceedings (once again, check with the state that you are purchasing them from), but either way you will own this property.

Risks Involved

Purchasing a tax lien certificate is secured by the real estate property, which means that there are two major risks involved that, with a bit of research, can be mitigated. First off, research the property’s title and make sure it is free and clear (other than the property taxes owed on it). This will ensure that if the property is sold to recoup the costs, you are first in line to receive the proceeds.

Secondly, make sure the owners are not in bankruptcy [8]. If so, then you could fall third to the IRS and creditors before you see your money from your certificate, or from acquiring the deed to the property.

Finally, please be aware that tax lien certificates are not a liquid investment; your money is tied up until the property owner pays up, or you get the deed to the property and sell it.

Have you ever bought a tax lien certificate?