Buying properties for taxes owed sounds like a great way to get a deal on a house, and in some cases, it is. After all, one person’s loss is often another person’s gain. However, the process is not as simple as paying other people’s property taxes and acquiring a house. You may get the house in the long run, but even in the short term, you can make money by investing in property tax liens.
Property Tax Sales
Property tax sales occur when the homeowner fails to pay his taxes. The waiting period before the local tax collector intervenes and places a tax lien on the property varies by state. Once such a tax lien is placed on the property, there is no selling or refinancing until the lien is paid. The entity issuing the tax lien then creates a tax lien certificate for the property, which includes taxes owed, interest and any penalties. It is this tax lien certificate that is actually auctioned off at the tax sale. In many states, properties may sell at a tax sale within several months of nonpayment, but in other states, the sale doesn’t occur until no payments are made for a few years.
At the auction, which is held either online or at a courthouse, the highest bidder generally wins the tax lien certificate. That winner has the right to collect the lien and interest from the owner. A few states, however, use a bid-down process, so the winner is not the person willing to pay the most for the tax lien certificate but the party who will accept the lowest interest rate on the lien. The reason a municipality or county will accept the lowest rate rather than the highest rate on a lien is because this arrangement benefits the homeowner. Say the highest rate by statute is 18 percent, which is an incredible rate of return by any standard. It’s also a rate that homeowners with financial issues are probably not in a position to pay. By accepting a lower but still significant rate – at least compared to other types of investments – there’s a better chance that the homeowner can pay off the lien and interest and regain his abode.
Performing Due Diligence
When buying a house at a tax sale, inspecting the property is generally not an option. What you should do is conduct a drive-by and view the house as best you can from the street. If you fail to do this and win the bid, you may find that the house is in severe disrepair obvious to the casual observer or even worse – that the house doesn’t actually exist. The homeowners may have stopped paying taxes because the house was destroyed in a fire or other disaster. In that situation, you may have paid off the property taxes on what is essentially a vacant lot or a dwelling requiring costly demolition. You may have paid more for the tax lien than what the property is worth. When first starting out, it’s wise to stay local and consider buying tax liens in neighborhoods with which you are somewhat familiar. You should already have an idea of what a similar property might bring on the open market. It’s only after getting your feet wet with successful tax lien sales that you should consider venturing into unknown territories.
You also need to make sure that the local government did its due diligence when placing a lien on the property. That means a trip to the local tax collector to inspect their records. It’s not unheard of for a property to end up at a tax sale because the local authority made an error or didn’t apply payments. For example, perhaps there is no evidence in the records that the tax notice was ever sent to the homeowner.
Tax Liens vs. Tax Deeds
More than half of the states do not conduct tax lien sales on properties, but they do offer tax deed sales. These differ from tax lien sales in that if you are the winning bidder, you do become the owner of the property right away. The tax deed per se is issued by the local government. In tax deed states, the homeowner does not have the option to buy back the property as she does in a tax lien state. If you want to buy a home for your own use or for renovation and resale, head to a tax deed state to do so. While you must perform the same due diligence as needed in tax lien situations, there is some extra work involved. That includes ensuring there aren’t other types of liens on the property, including a mortgage or home equity loan. Mortgages are technically liens on a property. Fail to investigate this, and you could end up buying a property and having to pay off additional debts. Once you own a house through a tax deed, you are immediately responsible for paying property taxes, utility bills, insurance and all other aspects of home ownership.
Getting Their House Back
Just because you were able to buy a home for taxes owed doesn’t mean the former owners are out of luck in a tax lien state. Every such state allows the owners time to pay off the lien after it is purchased. How long depends on the state, so figure that it could take months or even years before you know whether you can ever move into the house if that was your goal.
If the homeowner files for bankruptcy, that may give him more time in which to get his house back. A bankruptcy could also lower the amount of interest you receive on a lien since a bankruptcy judge might lower the homeowner’s interest rate to allow him to regain his financial footing.
Making Money with Tax Liens
Keep in mind that the laws regarding tax liens vary by state, and no matter where the property is located, the process is complicated. Buying properties in which you plan to live or fix up and sell isn’t a good idea for the novice. However, you can make money with tax liens without the need to ever consult a contractor.
When you purchase a tax lien, you must pay the entire amount of the lien back to the county or municipality that issued it. If the homeowner wants her money back, she must pay you the amount of the lien plus interest. As with everything else regarding tax liens, much depends on state law, but these interest rates may prove to be quite high. The owner’s repayment schedule may last between six months and three years. During this time, you are collecting interest at a far higher rate than you would receive from a bank and possibly getting a return better than the stock market average in a good year.
If the owner can’t pay back the lien by the repayment schedule’s deadline, you can start foreclosure proceedings on the property. This is why performing your due diligence is so critical. An owner probably isn’t going to make the effort to pay the back taxes on a property in terrible condition or one that has some sort of environmental problem, such as a leaking oil tank that requires tens or even hundreds of thousands of dollars for area remediation.
- In many states, county tax collectors provide a list of the properties that will be available at public foreclosure auctions prior to the date of the auction. This may be a great time to visit the properties and determine if they are attractive investments.
A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including PocketSense, Zack's, Financial Advisor, nj.com, LegalZoom and The Nest.