Real Estate
Investment
What are Tax Liens?
While
this topic may not clearly fall in the category of 'real estate
investing', it is worth mentioning owing to the following reasons. In 'Tax
Lien' States as against Tax Deed States, the state will usually sell a tax
lien to an investor for the taxes that are overdue. The owner of the tax
lien is thereafter entitled to collect interest on the money that was paid
for the tax lien from the home owner. In case the tax lien along with
interest goes unpaid, the investor can foreclose on the home. Unlike most
other foreclosures, when a tax lien is foreclosed on, all other liens and
mortgages are abolished and the property would be owned 'free and clear'
and typically the lender will pay off the tax lien to avoid this
situation.
Information on tax liens
seem to be thrown at you from every side, nowadays. However you need to be
cautious since most of these 'overnight' experts don't tell you is what
could go wrong with your investment if you fail to perform proper
research.
Tax lien general
information can be found a 'dime a dozen' in marketing-based products.
Unfortunately, many of these products will keep you wholly fascinated and
perplexed with this investment technique...especially since most will
avoid the hard questions regarding negative aspects and the risks that
don't show up in the sales letter. Read on for more
information:
I. Introduction
to Tax Lien and Tax Deed Investing
Earning 16% to 24%
interest through a low risk and low maintenance investment is rare. While
some investments in real estate or industry can match such high rates of
return, few can equal the safe and passive cash flow potential of property
tax liens. Further, tax lien instruments are normally insulated from
changes to Federal Reserve interest rates. Another advantage is that the
property tax lien is secured to real estate property as a first priority
claim.
The end result hence is
a highly secure investment instrument that can provide the investor with
either:
1) A favorable return on the money invested, or else
2) Deeded rights to
property.
More impressive is the
fact that tax liens can be purchased for nominal amounts of money like
less than $200) or at larger sums of $30,000 or more. The end result here
is a flexible yet highly secured investment with minimal downside and
market risk.
II. Tax
Liens vs. Tax Deeds
Tax liens or tax deeds
are sold in 35 of the United States and almost every state and territory,
in the country has a process that is used to collect delinquent property
taxes and place reliable taxpayers back on the tax rolls. This process
usually occurs at the last juncture of the tax collection process and it
allows ordinary individuals to purchase the rights of local governments in
cases of tax delinquent properties.
The process can be
divided between two general types of systems:
o 'Tax lien systems'
o 'Tax deed systems'
The tax lien and tax
deed processes may be differentiated by the set of rights sold to the
purchaser. In states using a tax deed system, if the taxes are not paid,
the county governments will sell full ownership and possession rights to
the investor. Currently only 17 states authorize the sale of ownership
rights to tax delinquent property by means of a tax deed sale or
assignment deed. Conversely, in the 'tax lien' states, the 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 investors or the general public.
What is the Tax
Deed Process?
In a tax deed state the
county will sell all of its rights to the property either at a public
foreclosure auction or through another later assignment process. The sale
will generally occur 3 to 5 years after the first tax payment became
delinquent and the 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 usually acquire full property
rights at a fraction of the market price. The purchaser will subsequently
obtain full ownership rights or at least all rights held by the county. In
these states, the purchaser normally has the customary rights of a
landowner, namely to possess and / or occupy the property.
What is the Tax
Lien Process?
In a tax lien state,
counties do not sell property; instead they sell their lien for unpaid
property taxes and this lien is an enforcement right held by the county.
Although the lien does
not grant full ownership rights to the property, it does provide the
investor with two important rights:
1) The right to demand 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 in the event that the lien is not paid.
The property tax lien is
a high priority lien which is superior to judgment liens, mortgage liens,
trust deeds, and other private liens. Owing to the powerful nature of
these rights, tax liens are a very attractive investment opportunity.
Moreover, since the property tax lien is usually only for a small fraction
of the properties' market value the investment is bound to be highly
secure. In addition to this, the lien purchase does not subject the
investor to undue land owner liability since no right to possess or occupy
the property is granted at the time of the sale of the lien.
III. The Tax
Lien Process:
The 16% to 24% interest
rates available to investors who purchase tax lien certificates is a
function of the state law that is, it is the state law that authorizes the
substantial return awarded to the investor.
History of
Taxation
Taxes based on property
ownership can be traced back very early; however our modern system draws
its roots from fourteenth century in England where property ownership was
first used as a measure of one's ability to pay the tariffs or taxes
levied by the English Crown. This tax later became assessed on the
property itself.
Property taxes were
implemented 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.
Late Taxes and
Collection of Taxes
Taxes linked to property
are still used to fund many of these same essential public services and
the fundamental importance of these services is the foundation for the
high priority position of the property tax lien. Almost uniformly, state
legislatures have given property tax liens more priority over judgment
liens, mortgage liens, trust deeds, and other types of private liens. This
ensures that money for public services is paid first no matter how many
other claims or charges are levied on a real estate property.
In most states, property
taxes are due only several months after the close of the calendar year.
Certain states divide payments into two or three installments each
becoming due at different times during the year. Though 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 for or
else the lien is foreclosed.
Tax liens held by the
county against real estate property do not by themselves provide the
county with actual revenue or money required for its operations. Until the
delinquent tax amount is collected the lien is simply uncollected debt.
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 repeatedly notify the delinquent taxpayer that their taxes are
overdue and 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 and after
one year of delinquency the county treasurer or tax collector will begin
to assemble tax sale listings for the upcoming year.
Preparations for the Tax
Lien Sale
The list of liens will
include properties that have been certified as delinquent for one year or
longer. Property owners, participating in a delinquency payment plan, will
usually 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; and 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 a bid to give the owner a fair chance to make amends.
In almost all counties sale listings are available 3 to 4 weeks before the
upcoming sale and they also have sale information online or can readily
fax sale lists to investors.
About the Tax Lien Sale
Auction Format
Although variations
exist among tax lien states, there are certain general similarities.
o Firstly, all primary sales must be held in a public auction
format and ordinary citizens are allowed to take part in the sale.
o Second, the starting price
for the tax lien is made up of the following:
1) Delinquent property taxes
2) Penalties
3) Assessments
4) Other charges or fees
While some variations do
exist among the bidding systems across tax lien states, most can be
categorized as follows:
1) Bid Up Process:
Certain States use a process in which the price of the lien is bid up or
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 usually fluctuate due to bidding.
Examples of states that use 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 which the interest rate earned on the tax lien certificate is bid
down or reduced and 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 usually rise due to bidding. Examples of states using
this system are: Arizona, Florida, Maryland, New Jersey and Missouri among
others.
A few other unique bid
systems do exist in a small number of states. However, no matter what type
of bidding method used there are numerous opportunities for the investor.
IV. The Tax Lien
Investment:
The tax lien investor
can earn a 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 along
with 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 ownership of
the property.
Tax Lien
Redemption
For the delinquent
taxpayer to be able to save their rights to the property they must pay the
investor the amount of the back taxes apart from 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 components. This time frame depends on state
law and can range from 1 year to 3 years, the timeframe being called the
redemption period. Interest rates vary according to state law but normally
range from 12% to 24% per year. Interest rate accrued varies based on the
number of months the investor holds the certificate.
Tax Lien Foreclosure and
Large Profits
The most powerful right
of the tax lien holder is the right to initiate foreclosure proceedings
which should begin if the cost of the tax lien with interest is not paid
off within the redemption period. Proper foreclosure grants the tax lien
investor full ownership rights in the property in question and will
eliminate the ownership rights of all other parties. In case the
delinquent taxpayer redeems the certificate during the start of the
foreclosure proceedings, most state rules allow the investor to add the
foreclosure costs to the redemption price.
Interestingly, since tax liens usually amount to less
then 10% of a properties' market value, foreclosure tends to create a
tremendous profit windfall for the tax lien investor. For instance, with
proper research, an investor foreclosing on $5,000 worth of tax liens can
acquire a property valued $55,000 or more. Therefore, a loan-to-value
ratio of 10% is possible and seemingly unequaled since $5,000 +
foreclosure costs / $55,000 =
10%. Many traditional and
creative forms of real estate investing can normally only create loan-to-value
ratios of 70% or more. < /FONT
>
V. Tax Lien
Holder Advantages and Rights
The purchaser at tax
sale will receive a certificate of purchase and hence 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 and 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 these
rights and advantages:
1) The Right to
Collect Interest or Foreclose: The prudent investor will earn profit on
the lien certificate irrespective of the outcome. In case the lien is paid
off by the delinquent property owner through redemption, then the investor
can usually expect to receive a double digit return on the original
investment. On the other hand, if redemption does not occur the investor
can foreclose on the certificate after which, the investor will obtain
full ownership rights to the parcel. Moreover, since property taxes are
only a small percentage of the market value, the investor stands to earn
substantial profit from the transaction.
2) A High Priority
Lien Holder Position: At the tax sale the investor purchases a tax lien
that was once held by the county. The priority position of the property
tax lien is not diminished because a private party now holds the lien;
instead, the investor holds the same rights that were once held by the
county. Since the lien occupies a first position on the land title,
foreclosure of the tax lien clears almost all other liens from the title.
Foreclosure hence not only places full property ownership in the hands of
the investor, but it also purges the land title of other subordinate liens
and debts. The end result is a property interest that is generally 'free
and clear' of any other obligations on the title. Exceptions to this do
exist though.
3) No Landowner
Liability or Maintenance Responsibility: An often slighted 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 while 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 at
par with a property owner. Since the tax lien investor is not a possessor
of property, there is also no landowner liability. This is clearly an
advantage as lawsuits against property owners / operators continue to rise
with time. The lack of control over the property creates an asset
protection feature for the tax lien investor and after foreclosure the tax
lien investor will have complete possession of the property.
4) Enforcement
Rights without Enforcement Duties: Another advantage is that the tax lien
investor need not necessarily demand payment or start collection efforts
to compel payment from the defaulted property owner. Though the lien is
now owned by a private investor the county will still handle enforcement
of the lien until foreclosure is completed. Certain states will actually
handle the foreclosure process for you irrespective of whether or not
there is contact with the delinquent taxpayer. Moreover, in the redemption
scenario most state tax offices take care of the collection of redemption
money plus interest. The investor will receive a notice indicating that
payment has been made to the county and most states will require the
investor to mail back the actual tax certificate in return for the funds
invested along with the interest component.
5) The Right to
Purchase Later Year Tax Liens: Liens sold at an auction are only for one
year's delinquent taxes. If the property owner defaults on next year's
taxes as well, then the investor has the right to privately acquire these
taxes without competition. This can maximize investment performance
depending on the tax lien jurisdiction and this 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 smart investor.
The numerous purchase opportunities and the high security/low risk nature
of tax liens ensure that this is an extremely attractive option to many
interested in active forms of real estate, stock and bond market
investment.
6) Tax Lien Sales
and Post Sale Opportunities: The tax lien purchaser is also favored by the
surplus of tax lien instruments that are also available for purchase. For
instance, at the 2003 Maricopa County, Arizona tax sale 21,200 liens were
available for sale but only 14,156 liens were sold and 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. Though Arizona's Maricopa County is a
very popular destination for tax lien investors, thousands of liens are
still available for purchase after each sale and 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 and profitable
exercise.
VI. Tax Lien
Investing - Risks Involved
While Tax lien investing
does have numerous advantages, there are also risks and traps for the
novices. As with any type of investment, real estate or otherwise,
technique and a proper understanding of the processes involved are
crucial. The general risk areas which can plague investors are listed
below:
Failure to Research
Property can prove risky
Viewing the Property
before buying:
Property research is
important before purchasing any type of real estate and tax lien
investment is no different. Since the real property gives the lien its
security and value, viewing the property is highly recommended. You may
decide to view a parcel yourself or else use a 3rd party. Many investors
make it a point to 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, an example of which is the 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 called for. In fact, there are detailed
selection criteria for investors who plan to view the property and those
who do not. Applying these steps in their precise order is fundamental for
success in this process.
In summary, it is
important that someone reliable if not for yourself should view the
property.
Researching Value:
The failure to
accurately determine market value of real estate property backing a tax
lien certificate is an unnecessary risk. County appraisal data is easily
available online for almost 70% of counties in the United States of
America. Even more exciting is the fact that this number will only
continue to rise and for counties without online data information is just
a phone call away. While 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 vital information on any zoning
regulations that may impact the use of the property.
Environmental Risks
posed:
The tax lien purchaser
is thankfully not an owner of property for environmental liability
purposes. Federal law has exempted lien holders who foreclose on
contaminated property allowing them to maintain lien holder status and
avoid any liability. These rules are always subject to change so it is
best to perform a few basic steps before buying. First, call the state
environmental agency; this usually is a worthwhile step for the beginner.
The investor is also better served by focusing on subdivision lots or
houses and the likelihood of environmental liability with such
'subdivision' properties is greatly diminished; so also the property has a
quicker re-sale potential. When working a new county an understanding of
the geographic area is also worthwhile. In summary, environmental risk
exposure while investing in tax lien certificates is less than that found
in other forms of real estate investment. Do remember though that no
possession generally also means the absence of landowner liability in most
states.
What if one
fails to Research a Title?
Surviving Liens and
Encumbrances:
Property tax liens are
superior to other types of liens like judgment liens, mortgage liens,
trust deeds, and other private liens. Nevertheless, some liens share equal
priority as the tax lien. For instance, 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, and thus survive the
foreclosure of the tax lien. The investor is unlikely to be responsible
for a payment since the Federal government has its own 'right to redeem'
which generally lasts for 120 days after the foreclosure of the tax lien.
The investor is entitled to receive attorney's fees, interest, and costs
incurred in the optimum upkeep of the property.
No investor should
however have to contend with state or federal tax liens since simple
research can quickly detect such liens. In order to locate this
information it is necessary to look out 'hidden' traps associated with
researching title. It is imperative that you get good instructions while
proceeding forward and your goal should be investment certainty through a
streamlined research process, not confusion from erratic methods. It is
best to refrain from investing in tax liens without fully understanding
this area.
Declaration of
Bankruptcy by the Delinquent Taxpayer
Tax lien jurisdictions
work meticulously to exclude liens from the sale if they have pending
litigation such as bankruptcy since this can create a risk for the
investor. If a bankruptcy occurs after the tax lien purchase, the tax lien
holder is customarily given high priority when the debts of the bankrupt
estate are paid. Very seldom does the tax lien not get paid off during a
bankruptcy proceeding and the end result is a favorable rate of return for
the investor.
The only troublesome
scenario that may occur in a bankruptcy is when laws may allow the trustee
to pay the expenses of administering the bankrupt estate before paying off
the tax lien. This is an uncommon practice though and would require
sufficient grounds, like the tax lien debt being so high that payment
would make it nearly impossible to administer the bankruptcy - this would
be a difficult position for the bankruptcy trustee to win. So also if the
investor follows certain cost guidelines while selecting a lien, this risk
can be virtually eliminated. In the end, even bankruptcy can have barely
any effect on a tax lien investment if proper precautions are applied.
Implications of FDIC
Held Liens
When a bank fails due to not having enough money, any loan owed to the
bank is administered by the Federal Deposit Insurance Corporation or FDIC.
If a loan administered by the FDIC is attached to a property on your list,
then it is best to move on since FDIC liens can create issues during
foreclosure, like delays. The good news is that it is very easy to check
for FDIC administered loans during a review of title since a list of FDIC
institutions is available online. Once you obtain the list you should
check the FDIC list against mortgage holders if they do exist on the
property. Moreover since most tax lien certificates are definitely
redeemed, the risk of a delayed foreclosure due to a FDIC administered
lien is quite remote and also easily avoidable.
Title Certification Vs Suit to
Title
At one time obtaining a
title through a tax foreclosure sale required a title clearing suit before
the land could be sold with financing from the bank. Those days are soon
coming to an end with the advent of title certification processes which
are relatively simple and inexpensive processes that confirm titles to
lenders, which in turn creates numerous opportunities to sell the property
with bank financing. Irrespective of this, some investors will choose to
sell the property to another investor using non-traditional means, such as
a below market value price or wholesaling. Depending on preferences,
investors may also wish to rent out or opt for owner finance properties.
Appreciation and interest on owner carried financing can convert a small
tax lien investment into a cash flow vehicle demonstrating astronomical
returns.
What are the
Variations in State Procedures?
Understanding Differing
State Procedures:
A firm analysis and
understanding of the laws in your investment state is critical especially
since 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 and can provide current and
realistic information to new and experienced investors alike.
VI. Some common Tax Lien
Investor Preferences
While some risks do
exist with tax lien investing, these can be avoided by conducting simple
research before embarking on the investment venture. Proper and systematic
research techniques will award the tax lien investor with numerous
benefits and usually very few headaches. It is good to remember that tax
liens can provide the investor with a safe and secure rate of return that
outperforms many other passive investment vehicles, like stock and bond
market investments.
The low maintenance
aspect of tax lien investing usually makes this a viable option to many
active forms of real estate investment and investors who do not wish to
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 while full-time investors who desire
property ownership can also take advantage of liens which have expired the
respective redemption periods. These liens options are available in every
tax lien state.
Tax lien investing will
also equip the investor with some control over the end results since rules
can be manipulated depending on whether the desired end result is property
ownership or a stated rate of return.
Common Property
Ownership Strategies:
The prudent investor
will earn profit on the lien certificate irrespective of the outcome and
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 usually
redeemed less frequently.
Common Redemption
Strategies:
Conversely, an investor
interested in redemption would target owner occupied properties with
attached mortgages since the more an investor utilizes these processes the
more the predictable the outcomes become.
VII. In
Conclusion?
Careful investigation of
tax lien certificates will allow for safe and quick wealth accumulation
since this investment technique combines tremendous upside potential with
very manageable and negligible amounts of risk involved.
A summary of these
advantages include:
o A High Priority Lien Holder Position
o The Right to
Collect Interest or Take Title to Property
o Enforcement Rights
without Enforcement Duties
o No Landowner Liability or
Maintenance Responsibility
o 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 over and over again with consistently good results. This
is owing to the fact that the same legal processes create consistent
opportunities year after year, hence resulting in a steady inventory of
tax liens. These investments will also help local governments fund
important civil services.
It is important however
to keep in mind that the rules forming the process are subject to slight
variations as time passes, so keeping up with changes in the law is
necessary. Tax lien investing is a significant opportunity which also
requires a certain degree of specialized knowledge. The faster one manages
to 'learn the ropes' the easier it is to see your investment grow hundreds
of times over.
Here's a simple formula
to follow:
1) Learn the process, and then
2) Repeat the process until you feel that you have
acquired enough wealth!
