If you’re looking for profitable real estate investments but don’t want the responsibility of owning and managing property, consider investing in tax liens. This indirect method offers a chance to profit from real estate without direct property ownership. Before you begin your investment journey, it’s important to familiarize yourself with the details of investing in tax liens.
Understanding Tax Liens
Tax liens materialize as legal consequences when property owners neglect their property tax obligations. Once a tax lien is enacted, the property, such as a residential property, becomes unmarketable and unfinanceable until the outstanding tax debt, accompanied by associated charges and interest, is satisfied. Failure to settle the debt grants the issuing entity the authority to seize the property.
Tax liens originate from the city or county where the property is situated. These entities create tax lien certificates that are often auctioned off to investors.
Investing in Tax Liens
Tax lien investments primarily yield returns through the accrued interest on the lien. Unlike compound interest, tax lien interest is simple. It’s crucial to note that interest rates fluctuate by state. For instance, in Iowa, tax liens can accrue a monthly 2% on the unpaid balance, while Florida permits interest rates as high as 18% on liens.
Not all states permit the transition of tax liens from the public to the private sector. Tax lien sales are allowed in the following states and the District of Columbia:
- Alabama
- Arizona
- Connecticut
- Colorado
- Florida
- Georgia
- Indiana
- Illinois
- Iowa
- Kentucky
- Louisiana
- Maryland
- Massachusetts
- Mississippi
- Missouri
- Montana
- Nebraska
- New York
- New Jersey
- Ohio
- Oklahoma
- Pennsylvania
- Rhode Island
- South Dakota
- South Carolina
- Tennessee
- Vermont
- West Virginia
Pros and Cons of Tax Lien Investments
Contemplating tax lien investments involves considering the associated benefits and drawbacks. Below are some of the pros and cons associated with a tax lien.
Pros:
- Accessibility: Tax liens can be entered with investments as low as a few hundred dollars, offering greater accessibility than real estate or mortgage notes.
- High Yield Potential: Depending on the state, tax lien investments can yield returns exceeding traditional assets like bonds, particularly in states with generous rate caps.
- Portfolio Diversification: Tax liens aren’t tied to market fluctuations, enabling effective portfolio diversification, potentially across various jurisdictions.
- Predictability: The known return on tax lien investments sets them apart from market-based investments, with an expected expiration for anticipated earnings.
Cons:
- Diminished Earning Potential: The competitive bidding process can lower earnings, potentially reducing returns.
- Payment Uncertainty: Property owners might not fulfill their tax lien obligations, necessitating a time-consuming and costly foreclosure process.
- Problematic Properties: Defaulted liens may result in ownership of a problematic property, which could prove challenging to sell or offload, particularly if the property has significant issues.
Purchasing Tax Liens
Acquiring tax liens involves specific steps:
- Location and Auction Selection: Choose a jurisdiction and become acquainted with local tax lien rules and auction schedules, which might be online or in-person.
- Due Diligence: Thoroughly research properties before bidding, considering potential liens and property conditions.
- Upfront Payment: Tax liens necessitate immediate payment of the lien amount, penalties, and fees to recoup lost taxes.
Purchasing Tax Liens with Retirement Funds
Tax liens can be bought using personal funds or as part of a retirement account strategy, but with specific considerations:
- Self-Directed Retirement Accounts: Standard retirement accounts are limited in the assets they can hold. A self-directed retirement account like a self-directed IRA (SDIRA) is needed to invest in tax liens.
- Custodian Selection: Identifying a custodian that offers SDIRA accounts, as most major banks and brokers don’t, is essential.
Assessing Tax Liens as Investments
Tax liens can be rewarding investments with thorough due diligence. Investing in them can provide lower costs than owning property and the potential for higher returns than traditional assets. However, the possibility of inheriting problematic properties or encountering unforeseen obstacles underscores the importance of research.
Before investing in a tax lien, conducting thorough research on the property is important to minimize any potential risks.