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Tax Lien Investing

Last updated 29th Nov 2022

The practice of paying delinquent property taxes for another party is known as tax lien investing. When an investor purchases a tax lien certificate, they become a lien holder on the property. This gives the investor a legal right to foreclose on the property under certain conditions. In fact, the property cannot be sold, or refinanced, until the lien is satisfied.

The Tax Lien Process

The process is somewhat complex, but it is also fairly consistent across the United States. In most cases, the tax lien process starts when a homeowner is delinquent in paying real estate taxes, or other fees collected by the city or county tax authorities. The thresholds can vary by state, but after a certain period of time has passed, the city or county government has a right to issue a tax lien against the property in question.

Additional Resources

The lien is usually sold at an auction held by the county at pre-established intervals throughout the year. These auctions proceed very quickly, and each bidder is usually required to fill out an application before participating. Prior to each auction, the county will also run a public notice in local papers, which includes the auction's date and time.

The county tax office will have all the materials and information needed to participate in an auction. Keep in mind that rules and applications may vary with each county. Don't assume that an application for one county can be used in another.

Sales and Auctions

The exact sales process will vary from state-to-state, and although most auctions require the bidders to be physically assembled at a given location, online or internet-based auctions are becoming more common.

Winning Bidders in Auctions

Oftentimes, there are multiple parties interested in the same lien. When that happens, the rules of the auction will determine the winning bidder. Normally, tax lien auctions will use one of the following five methods to determine the successful bidder:

  • Bidding Down Interest
  • Premiums Paid
  • Randomly Selected Winners
  • Rotating Winners
  • Bidding Down Ownership

Each of these bidding processes is explained in more detail below.

Bidding Down Interest

Under the bid down interest method, the stated rate of return offered in the auction is considered the maximum rate allowed. In this type of auction, each bidder is allowed to bid down the rate of return. The bidder willing to accept the lowest rate of return is the winner of the lien.

If there are multiple investors willing to accept the same low rate, then one of the methods described below can be used as a tie breaker to determine the ultimate winner.

Premium Auction

In a premium tax lien auction, the winning bidder is the investor willing to pay the highest premium. A premium is the excess amount the bidder is willing to pay over the lien price. Premiums are not paid back to winning bidders, and often interest is not payable on those premiums.

Random Selection

In some jurisdictions, the winner of a tax lien is randomly selected from those willing to bid. Normally, a computer using a random number generator is used to make the selection, but some jurisdictions may use simpler methods; akin to picking a name out of a hat. This method is often used when it's necessary to break a tie.

Rotational Selection

Under the rotational selection of a winner method, each bidder is given a number. The first lien up for auction is offered to the person assigned to number one. That person can choose to buy or refuse the lien. If refused, then the tax lien is offered to the person holding number two. The process continues until someone accepts the right to purchase the lien. Bidders participating in this type of auction have very little control over what liens they will be offered.

Bidding Down Ownership Method

The bid down ownership auction is not very common. In this type of auction, the investor agrees to bid down the ownership of the property. The winning bidder is the investor willing to receive the lowest percentage of the lien proceeds if the lien is redeemed.

This is perhaps the least popular of the auction methods with bidders. Many investors are unwilling to split a property with another party, and participation in this type of auction may be less than robust.

Liens Not Sold at Auction

If a tax lien is not sold to investors at auction, they are considered struck, or sold, to the party holding the auction itself. This is frequently the county government. There are states that allow liens not sold at auction to be purchased in an over-the-counter manner. Many times, liens that are not sold at auction involve "worthless" property since bidders would certainly be interested in properties having any real value.

Essential Government Funding

The entire concept of purchasing a lien on someone else's property might be unpalatable to some individuals. Keep in mind the county depends on these taxes to provide essential services to their community. That is why the law allows for the auctioning of tax liens and tax deeds. By selling the lien, the county gets the funds it needs, and the investor inherits:

  • The rights to payment of the taxes owed, penalties, and interest payments.
  • The rights to the property itself, if non-payment occurs and foreclosure proceedings ensue.

Rights of Tax Lien Investors

In some counties, the lien holder agrees to pay any subsequent unpaid property taxes until the redemption period has expired. If the lien holder declines to pay any of these taxes, then another party can take possession of the lien.

Redemption of Tax Liens

When the redemption period expires, the lien holder can initiate foreclosure on the property. The foreclosure proceedings are initially paid by the lien holder, and usually result in the property's title being transferred to the holder or a tax deed sale. In the case of a tax deed sale, the holder usually has the right of first bid.

All through this redemption process, the original property owner has the opportunity to repay the lien and any interest due. In addition, the original property owner may also have to pay for the cost of the foreclosure proceeding. If the lien holder does not act within a given timeframe to foreclose on the property, their rights to the property are forfeited, and they no longer receive any return on their investment.

Risk and Return of Tax Lien Investing

If the taxpayer continues to make payments of tax and penalties, the investor is compensated for the risk they took. If payments stop, the investor has collateral, the property itself, which can be sold to satisfy the lien.

Keep in mind, this form of investing is not a new idea. There will be real competition for properties that are in good shape and possess real value. These same properties are likely to be sold before foreclosure ever takes place, which is still good for the investor, because their lien would be satisfied at sale.

About the Author - Tax Lien Investing

Moneyzine Editor

Moneyzine Editor