Tax lien investing explained  

Download an article written by tax lawyer on Tax Lien Investing: Everything You Wanted To Know About Tax Lien Purchases
	click to download concise explanation
What is a tax lien? In many USA States, if a property owner fails to pay annual property taxes, the county or municipality will issue a tax lien on that property. This lien obliges the property owner to pay the outstanding taxes plus penalty fees plus a punitive high rate of interest on the debt. The property owner must pay off this debt and interest to have the lien removed. In other States the local government will rather sell the property immediately with a tax deed sale. The investments we promote only invest in tax lien sales.
Investing in tax liens: If the lien and interest continue being unpaid for a few months, the local government will publicly auction the lien to obtain the outstanding debt. In effect, the buyer of the lien is paying off the property owner's taxes and fees to the local government.
Superior Returns: The owner of the lien, known as the lienee, accrues a high punitive rate of interest on the amount of the lien. If the property owner, known as the lienor, does not pay this interest and the outstanding lien, then the lienee is allowed to foreclose on the property after a redemption period, generally 6 - 24 months.
Potential for Windfall Profits: There are only two outcomes for a lienee: Collect high interest until lien is paid off, or Foreclose on the property and receive clear title to that property. The property value is usually 5 - 100 x the value of the lien. In most cases the property owner or other creditor, such as mortgage provider, will pay the interest and outstanding lien.
Low risk: Almost all tax liens and interest are fully redeemed by the property or mortgage provider. The ultimate incentive is the threat of foreclosure over a comparatively small debt. If the lien debt remains unpaid, the lien holder can foreclose on the property, allowing the lien holder to obtain title to the property at 80% to 99% below market value.
Investments are secured: Real estate tax liens are placed against the title to real property by an entity of the government for unpaid taxes. The property owner cannot sell their property until the tax lien is removed by being paid in full. All other claims, including mortgage loans, are subordinate to the tax lien.
Tax lien purchases in a weak property environment: In falling real-estate markets tax defaults skyrocket. This affords more tax liens, increasing the opportunities to invest in high-yielding tax lien certificates. Approximately 40% are borrowers escrowed by the mortgage company, who will invariably pay off the lien.
How is interest and outstanding lien debt collected from property owner? The tax lien purchaser who bids the lowest wins the bid. After the tax sale the tax lien purchasers are presented with tax lien certificates by the county clerk. These certificates contain information like penalty rate, face amount, current assessee (owner), and property address. All redemptions by delinquent tax payers must be made to the county clerk. Once the county clerk receives the necessary amount to redeem, they will: Cancel the certificate lifting the tax lien against the property Forward all the proceeds from the lien to the lien holder (investor) If the full debt remains unpaid then the County clerk will authorize the lien holder to proceed with foreclosure. What this means is the investor either receives full payment with interest or receives no payment but can foreclose on property. The lien holder will not receive any partial repayments.
What are the different types of tax lien bidding processes? Rate: This is where the bidder prepared to accept the lowest rate, wins the right to buy the lien Penalty: The successful bidder at a tax certificate sale is the person willing to accept the certificate with the lowest PENALTY percentage. For instance in Illinois, the maximum penalty on none farm land is 18%. This is a PENALTY - NOT INTEREST. The penalty applies each six month period or fraction thereof prior to redemption making the annualized yield on a bid of 18% a minimum of 36%. If homeowner does not pay ongoing tax during the redemption period, the lien holder is allowed to buy new liens on the outstanding debt at the FULL penalty rate. Ownership: In some States, bidding is on a percentage of ownership basis in case of foreclosure. What this means is that the interest rate remains flat, but in the event of foreclosure, the investor and the property owner become co-owners of the property. The initial bid is with the investor starts at 100% and reduces until the lien is sold. This method is produces high lien interest rates. Iowa uses this method, which means that you are guaranteed a 24% rate. The disadvantage with this method is the potentially expensive legal hassle to take possession of the property if you co-own it with the delinquent owner. Round Robin: Here the bidding is on a round robin basis. The auctioneer offers the lien around the room until someone buys it. They are always at the maximum rate allowed by statute. In round robin states, you get a nice guaranteed rate of return on your tax lien certificate, and don't have to mess with the co-ownership issue. However, in round robin states, it is much more difficult to actually get the liens that meet your needs. If you decline during your turn, then you have to wait for luck of the draw to see if you get the lien that you want. If you are a big money investor, then the risk is low since you can buy many more liens. As a smaller investor who can only afford a couple of the liens on the book, this restriction can be very limiting.
Why does the State of Georgia have tax deeds that have characteristics of a tax lien? Lien investors act as debt holders and seek favorable interest rates, while deed investors make their money on the equity split between the deed price and the property value. Most states offer either liens or deeds, but a few states, such as Georgia, hold attractions for each type of investor. Investors in Georgia tax deeds have the security of knowing they will either receive an annual return on investment of at least 20 percent or receive the entire property for what is likely significantly less than market value. Georgia allows delinquent property owners a one-year right of redemption period during which they can redeem the property by paying off their outstanding debt. If this occurs, the tax deed operates much like a tax lien, with the exception that the deed holder must issue a quit claim deed to transfer title back to the property owner. Georgia’s deed holders are entitled to repayment along with a 20 percent penalty regardless of when during the year redemption takes place. If redemption occurs in the first month, this offers the possibility of a 240 percent annual return. If redemption does not occur, the deed holder can foreclose on the property and become the owner.

• No Fees: A tax lien purchase is a no load investment, and no additional fees are levied on investor.
  
  
• No liability on property: Although the lienee has the right to take possession of the property in case of delinquency, the lien holder does not own the property and therefore does not have any liabilities associated with property ownership such as insurance, maintenance, etc.
  
  
• Windfall Profits: Whenever a property is foreclosed, the investor will receive significant profits.
  
  
• Security: Risk of any loss is negligible. All tax liens are secured by real property with an assessed value of 5 to 100 times the amount of the lien. The liens have been issued by county and city governments for non-payment of property taxes. Under state law, the liens take priority over other creditors such as mortgages, giving them a strong secured position.
  
  
• Fixed Principal: Unlike equities and bonds, the principal value of tax lien investments does not vary.
  
  
• Assured income: Unlike normal property income rentals, the property holder or mortgage provider has maximum incentive to pay the lien and interest or face the total loss of the property due to a comparatively minor debt. Statistically, at least 96% liens have been repaid in full.
  
  
• High yield income:
  
  

  State	Mandatory Interest	Redemption Period	Lien / Deed
  ARIZONA	16%	3 years	Lien
  CALIFORNIA	18%	2 years	Deed
  CONNECTICUT	18%	2 years	Lien & Deed
  DELAWARE	15% penalty	1 year	Lien
  FLORIDA	18%	2 years	Lien & Deed
  GEORGIA	20% penalty	1 year	Deed with redemption period
  ILLINOIS	36% p.a. penalty (18% for 6 months)	2 years	Lien
  INDIANA	10% 15% - 25% penalty after 6 months	1 year	Lien
  IOWA	24% may become co-owner in case of foreclosure	1.75 years	Lien
  LOUISIANA	12% + 5% penalty	3 years	Lien & Deed
  MARYLAND	10% to 24%	0.5 - 2 years	Lien
  MASSACHUSETTS	16%	6 months	Lien
  MISSISSIPPI	17%	2 years	Lien
  MISSOURI	10% + 8% penalty	2 years	Lien
  NEBRASKA	14%	3 years	Lien & Deed
  NEW HAMPSHIRE	18%	2 years by municipality	Lien & Deed
  NEW JERSEY	18%+	2 years	Lien
  NEW YORK	14%	1 year, in lien counties	Lien & Deed
  OHIO	18%	1 year - if county pop. 200,00+	Lien
  RHODE ISLAND	16%	1 year by municipality	Lien
  TEXAS	25%	2 years	Lien
  WASHINGTON DC	12%	6 months	Lien
  WISCONSIN	18%	2 years, by county	Lien & Deed
  WYOMING	18%	4 years	Lien

  
  
  

• Tax liens are illiquid: They must be held until fully repaid or the lien holder forecloses at the end of the redemption period. While tax liens can be transferred to another party, they cannot be encashed. However, new market makers are establishing a secondary market in liens.
• Property problems: If the investor does end up acquiring the deed to the property, they also acquire any problems associated with the property such as interim damage, environmental issues or survey problems which could make the property useless.
• Erroneous liens: If the property owner proves that the tax collector was at error to place a tax lien, the lien holder would regain the principal but earns no interest.
• IRS claims: Debts to the Internal Revenue Service have priority over all liens, and they could foreclose on the property during the redemption period. The lien holder would then be repaid principal plus 6% p.a.
• Quitclaim deeds: are not forms of marketable title or insurable title. The investor will incur additional expenses to obtain these higher levels of title in order to eventually sell it in case of foreclosure.
• Bankruptcy: If the property owner declares bankruptcy, the judge may reduce the penalty and /or interest amount owed to the lien holder or could even discharge the lien leaving the investor with nothing.

Video : Introduction to Tax Lien Investing: