Many investors and investment advisers fail to take advantage of non-traditional investment alternatives, preferring instead to invest in higher risk lower return assets. For example, most investors and investment advisers actively invest in or recommend mutual funds, yet few investors and even fewer investment advisers actively invest in or recommend investing in tax liens — even though tax liens can guarantee higher returns with significantly lower risks than other more traditional investments. This oversight is probably primarily due to investors and investment advisers being unaware of the benefits of tax lien investments.
State and local governments impose a tax lien on real property if a property owner fails to pay his or her taxes in a timely fashion. Many of these state and local governments then issue tax lien certificates after the expiration of a period of time following the filing of a tax lien. These certificates are offered to the public, typically on an annual basis through an auction process. Tax lien auctions are generally announced several weeks in advance via one or more local newspapers. Tax lien certificates can be purchased at these auctions for the price of the unpaid taxes or at a higher amount (at a premium).
Investors who hold tax certificates are entitled to interest payments as set by state law. The interest rate is typically a fixed amount that varies from state to state and year to year. Interest rates between 15% to 35% are common. The interest is simple interest, meaning that a $1,000 certificate will pay $12.50 each month that the taxes are unpaid.
The tax certificate holder is not repaid his or her principal outlay and does not receive any interest payments until the taxes are paid. Tax liens are secured by the underlying real estate and the lien is usually granted a first priority, meaning that the lien must be satisfied before other debts associated with the property. If the property owner fails to pay their tax liability within a specified period of time (typically three years), then the lucky tax lien certificate holder is entitled to seek to acquire full title to the underlying real property.
Title is generally granted by the courts via a simple foreclosure process. In most cases the government attorney will pursue these proceedings on behalf of a request from the tax lien certificate holder. Tax lien investors do need to do some research to determine if the underlying property is worth more than the outstanding tax liabilities. Investors need to be particularly concerned about undiscovered environmental claims, zoning problems, and potential FDIC or DEA involvement.
Bankruptcy can also be problematic; however, generally bankruptcy will only delay the time in which investors will receive payment and interest. In most cases, the state or local government will screen out properties with these types of issues prior to the auction date. Even then, a basic knowledge of the area in which the property is located and a search of the local property records are sufficient to discover most of these types of issues.
The majority of tax lien certificate holders receive payment, including interest payments, when a third party purchases the underlying real property. These funds are typically held by the state or local government in the property closing process and remitted to the tax lien certificate holder.
As a result, tax lien certificates present investors with a vehicle for a decent return with relatively little risk. With interest rates well in excess of 20% in some jurisdictions, many investors and investment advisers should be investing in and recommending tax liens as part of a diversified portfolio.