A tax lien can be thought of as a claim filed against a real estate property whose owner has failed to pay their taxes. The property usually can't be sold or refinanced until the lien is paid off.
In the United States, a lien can be filed whenever someone forgets or refuses to pay the amount owed, which can include the tax itself, interest charges, penalties and processing costs. A federal tax lien can be imposed for not paying income taxes, gift or even estate taxes.
What is a Tax Lien?
Tax liens can be filed by nearly all government agencies. Sometimes these liens are even filed by private companies or individuals. The lien usually involves real estate, although it can also involve other forms of personal property. A lien is placed on the property when the owner fails to pay, or is delinquent in paying, certain taxes. Less common are those involving fees owed to a government agency.
For example, in New York City, if someone doesn't pay their water bill and they've run up a balance of $1,000 or more owed, the City can file for a lien against property.
When a tax lien does involve real estate, and the property does exchange hands, the obligation of repayment is said to "run with the land." That means the new property owner is now responsible for repayment of taxes owed, even if the non-payment occurred because of a prior owner. This is one of the reasons a title search and title insurance are so important to new home buyers.
Tax Lien Rules
The thresholds will vary by state, but after a certain amount of time has passed, the county government has the right to issue a tax lien against the property if real estate taxes have not been paid. Once in place, the homeowner usually cannot sell the property without first paying the taxes and any penalties owed.
Because county governments need this money to provide adequate and essential services to all members of their community, the law allows for the selling of tax lien certificates, also known as tax deeds. This can be an ideal situation for both the investor buying the tax lien certificate as well as the county. The county gets the money owed, and the investor now has two claims by purchasing the certificate:
The right to the taxes owed, accruing tax penalties, and interest payments.
The right to the property itself through a foreclosure proceeding, if repayment is not made in a timely manner.
Profits from Tax Liens
Individuals may view tax liens as safe investments with high returns, because they're either going to be paid the money owed, or own the property. But like many investment opportunities that seem too good to be true, tax liens have their pitfalls too:
The time a lien certificate is held, and the process of notice before foreclosure varies. Investors need to check with the county tax assessor's office to determine the exact process.
A majority of liens are satisfied before foreclosure on the home or property takes place, especially if the property is in good condition.
Just like other investments, it's important to research the property involved in a sale. For example, does the home sit in a flood plain? What is the real value of the property? There will be a number of shrewd investors competing at the auction, so getting the best deal will take some legwork.
Federal Tax Liens
A federal tax lien can be placed on property if the owner fails to pay income taxes, gift tax, or inheritance / estate taxes. The process that occurs with federal tax liens is different than with property taxes. During the first step of this process, the person held liable for the payment of taxes is notified.
After formalizing the assessment against the party involved, a written "demand" is sent by the Internal Revenue Service (IRS). In most cases, the liable party has ten days after receipt of this written demand to pay the money owed. If the property owner fails to make payment before the tenth day, then a tax lien is automatically placed on the property.
Expiration of Liens
Unless another date is specified by law, a federal lien will continue until the assessment has been satisfied, or until the statute of limitations is reached, at which time the lien is no longer considered enforceable. Unless an exemption applies, the statute of limitations is ten years starting on the date of the assessment.
Notice of Federal Tax Lien
In some instances, multiple government agencies or other creditors may have in-place competing liens against the same property. When this occurs, "perfection" of the lien will determine which agency or creditor has priority. In most situations, the lien that was perfected first takes priority over all others.
The federal government will file a Notice of Federal Tax Lien, or NFTL, in order to "perfect" its lien, and also file this notice with state and county agencies where the property is located.
Liens Based on Property Value
When a lien is placed on a property and the tax is related to the property's value, federal law allows a state's lien to take priority over a federal one. This holds true even if the NFTL was filed prior to the state-issued lien.
Release of Federal Tax Liens
When the taxes owed have been paid, the IRS will normally issue a Release of the NFTL. Alternatively, this notice is sometimes issued when the IRS is no longer interested in collecting taxes owed. As a general rule, the IRS will remove the lien within 30 days of payment. The process is considered final when the taxpayer receives a Certificate of Release of Federal Tax Lien.
Liens versus Levies
While the NFTL provides the property owner with warning and intent to secure or seize a property; it is the Notice of Intent to Levy that provides the IRS with the ability to take or seize a property by any means possible.
In general, once a notice of levy has been issued, the IRS does not have to seek the permission of a court of law to seize the property. The Notice of Intent to Levy normally provides the property owner with 30 days to satisfy the tax lien before the property is legally taken.
Additional Resources
For many homeowners, property taxes represent a large proportion of their monthly mortgage payment. While politicians like to talk about lowering property taxes, in most towns across the nation, this tax increases nearly every year.
Moneyzine EditorDecember 5th, 2023
