Tax Lien Certificates

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There are many ways to invest in real estate, but one of the more interesting ways is through tax lien certificates. To be more accurate, you're not really investing in real estate - but you might wind up with a new home if the homeowner never pays their taxes. If you think this is an interesting concept, then keep on reading.

Tax Liens and Tax Liens Certificates

So what exactly is a tax lien or a tax lien certificate? Well, believe it or not, there are certain individuals that do not like to pay their taxes. (Shocking, huh?) With tax liens, we are usually talking about real estate or property taxes. For that reason we're going to start off this article by discussing tax liens associated with property taxes. Later on, we're also going to take a look at a second type of lien that has to do with federal taxes.

Property Tax Liens

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Property taxes are used by the county or municipal government to supply essential services to their communities. When taxes aren't paid, these government agencies are in a bind. They aren't getting funding they need, but they've still got expenses. Eventually the taxes have to be paid, but these government agencies need the money now. That's where tax lien properties come into play.

The tax lien creates a win-win situation. By issuing a certificate, the agency needing the property taxes gets paid by individuals investing in the tax lien. So the government is happy because they can pay their bills. The investor is happy too because they're in possession of a certificate that entitles them to certain benefits that they value.

Benefits of Tax Lien Certificates

When a tax lien certificate is purchased, it entitles the holder to certain guarantees:

A rate of interest on the outstanding balance on the lien. That is, the delinquent taxpayer not only has to pay the taxes due, but also an interest rate penalty on the taxes. This is the money owed the holder of the certificate.
Alternatively, if the taxpayer fails to pay the outstanding taxes within a pre-determined timeframe, then the holder of the tax certificate is entitled to the deed on the property.

This is why so many investors are interested in tax lien certificates. They've either got a chance to earn a high rate of interest on their investment - typically, interest rates on certificates can be as high as 20 to 50% - or they've got an opportunity to buy a home at a fraction of its market value.

Risks of Buying Tax Liens

If you understand the benefits of investing in tax liens, then you're probably saying to yourself - What's the catch? Well, as is the case with all investment, there is an element of risk and reward that applies here too. So let's talk about some of the risks associated with buying tax liens.

First Liens and Subordinate Liens

In many counties, or jurisdictions, tax liens are allowed to be first liens against a property. Holders of a first lien will own a property if the taxpayer cannot make payment on their back-taxes. That's because a first lien is not subordinate to others. When the state allows a tax lien to become a first lien, it is sold at auction and sometimes referred to as a tax lien certificate.

When you invest in a tax lien, you need to understand the rights that you are acquiring. That is, do other creditors have a claim to the property and do they have a legal right to be paid first? You need to ask this question, and understand the answer before buying a lien.

Homeowner Bankruptcy

Even though bankruptcy laws have changed, and now declaring bankruptcy is much more difficult, you still need to understand what happens if the homeowner declares bankruptcy. If that happens, the Internal Revenue Service or other creditors may have a claim to the property that needs to be satisfied first.

Worthless Properties

Another risk that a tax lien certificate holder needs to be aware of has to do with the property itself. Many investors purchase certificates without inspecting the property. Keep in mind that the owner is not paying their real estate taxes - and that situation may have been going on for quite some time.

It is very likely that a person that cannot afford to pay their property taxes cannot afford to maintain their home properly. If the home has been neglected long enough, the tax lien holder might be faced with costly repairs before the home can be sold.

The bottom line with all these warnings is that you need to do your homework prior to bidding on any distressed property. In fact, there are several online auction websites that specialize in distressed property sales - even eBay. But again, as a buyer you need to understand exactly what you might be purchasing. You might also want to track foreclosures in your region to see what types of properties are typically available in an auction.

Tax Lien Auctions

Tax liens and certificates are sold through an auction process. Anyone that can legally buy real estate or property in the United States qualifies to participate in these auctions.

Before you can bid in the auction, you will probably have to register. Observers or visitors are usually not allowed a seat at a tax lien sale. The IRS requires all tax lien issuers to send 1099-INT Forms to lien buyers. This means you will probably have to fill out a W-9 Form at the time of registration.

The exact bidding process will vary by jurisdiction, but the auction may separate properties that expect to receive premium bids (bids in excess of the property taxes due) from other properties. You also need to find out what are the acceptable means of payment - personal, certified or bank checks. Exact amounts are usually due immediately following purchase.

Finally, tax lien certificates are normally held in safekeeping at the county's tax or treasurer's office. However, you can usually have the certificate sent to you via a written request to the proper government office.

Federal Tax Liens

In the US, a federal tax lien may be involved whenever the homeowner does not pay federal income tax, gift or estate taxes. Federal tax liens work the same way county property tax liens do. If an individual does not pay their taxes, interest, or tax penalties, then the US government has a right to that individual's property via a lien.

Once the federal government has asked or demanded to be paid the taxes owed, the lien / assessment is made against the homeowner and it will continue to be in place until the debt is paid. This federal tax lien is valid without having to notify the taxpayer that the lien actually exists.

In addition, once a Notice of Federal Tax Lien (NFTL) is filed, this lien will have priority over all other liens on the property. There are exceptions to this rule when certain securities and motor vehicles are involved. If a state legislature elects, it can also enjoy a higher priority than the federal tax lien.

Online Tax Lien Information

If you're trying to find online tax lien information, the following states allow you to do state-wide searches of county or federal tax liens and where you can access online tax lien information - both federal and county - for that state: