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How to Make Successful Tax Lien Investments: A Cheat Sheet

by Ankit Duggal on December 31, 2013 · 14 comments

  
make successful tax lien investments

Risks are in every decision that we make in our lives.

Once you get out of bed in the morning your life filled with risk-adjusted choices. Driving your car, crossing the street or sky diving out of a plane. Life is filled with risk adjusted decision making.

Investing is no different!

Tax lien investing has great returns but can come with great risks as well. The premise behind tax lien investment is to have a near riskless high yield investment. So how can that be achieved?

As an investor you must accept that you cannot remove all risk, but you can substantially mitigate risks! How? Research!

Research and Tax Liens

Proper research and investigation prior to making a tax lien investment allows you to weed out the good investments from the bad and help make your investment less risky.

I created the following cheat sheet to help me understand and locate the risks associated with investing in tax lien investments:

RISK

RISK REDUCTION TECHNIQUES

Market Risk Market risk refers to the possibility that an investment portfolio will lose value due to changes in unsystematic variables, such as interest rates and GDP growth.Unlike investments such as stock or bonds, tax lien returns remain because the interest rates on tax liens are legally mandated and not susceptible to the fluctuations of the market. Market risk is inherent in any investment so the only way to reduce the risk is to not invest at all.
Property Risk Property risk refers to asset specific risk i.e. market value, liens, government risk.  Researching assets backing the lien carefully is a critical step to help you avoid the pitfalls of most or virtually all property risk.
Liquidity Risk Liquidity risk is a type of unsystematic risk that is prevalent in all   tax lien investments. An investment is considered illiquid if invested funds are tied up and can’t be liquidated within a short period. When you invest in tax lien certificates, you run liquidity risk. Although there is a small, secondary market where you could sell your position but it is not as liquid as stock markets.
Mortgages Tax liens have priority over senior liens including mortgages. Mortgages do not take first lien precedence over tax liens, and the lender’s interests are extinguished when the tax lien property is foreclosed on.
So no real steps to take to reduce the risk just having awareness of it is important.
IRS Liens When a property owner fails to pay personal or business income taxes, the federal government may file a lien against the property. In short, local tax liens trump federal tax liens. IRS/Federal liens impact risk profile associated with redemption. The US government has the right of redemption for 120 days from the date of such sale (26 USC Section 3712( g) and 7425 (d)). The IRS will pay the actual amount paid for the property by the bidder, plus interest at 6 percent per annum from the date of the sale, plus the expenses of sale that exceed any income that has been received from the property. The IRS lien can impact your return profile given 26 USC.
Environmental Risk Environmental risk refers to potential contamination that may reside in the soil of the asset. This is one of the biggest fears of beginning investors have when buying tax liens. There are a couple of ways to reduce this risk:

  1. Check to see if the state has an environmental website
  2. Check the EPA’s site location listings
  3. Request Open Records Act for each asset that you wish to own a lien on
Government Risk Government risk refers to asset condemnation and demolition risk. You can reduce this risk by following up with the construction department of the township to see if the asset is on their list prior to purchasing a lien.
Bankruptcy Risk Bankruptcy risk refers to the capability of the asset owner to seek protection from debtors through the US Bankruptcy code. Mitigating this risk requires a bit of detective work. You can determine this risk potential by looking into the asset owner name through the County Records to see if the following factors are present:

  1. Active Foreclosure Complaint on other assets?
  2. Other liens present under the name of the owner on the subject and other assets?
  3. Prior bankruptcy protection or foreclosure completion?

Utilize the cheat guide to mitigate the risks associated with making your next tax lien investment. Risks are a part of every day life but that does not mean investing has to be risky. Now you can make mitigate tax lien investment risks.

Happy Investing!
Photo Credit: K.Wiklund

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{ 14 comments… read them below or add one }

Sharon Tzib December 31, 2013 at 12:26 pm

Two questions:

1. You discussed IRS liens, but what if the property owner hasn’t paid state taxes? Do those trump property tax liens?

2. What happens if the property owner has filed a BK and you didn’t discover it prior to purchasing the tax lien?

Thanks!

Reply

Ankit Duggal December 31, 2013 at 5:41 pm

Two answers:

1. I presume you are referring to state income taxes then the same rules as old outstanding property taxes would apply, but the rule would vary from state to state.

2. Then you did not do your hw properly. Joking. In all seriousness, your lien face value would still be protected but your interest maybe at risk. However this is a great question as post bk filing a debtor would be outside of the US Bankruptcy filing protection in my opinion. I will consult with my BK attorney team member on this question and I will update my response once i get an answer from him.

Reply

Sharon Tzib January 1, 2014 at 11:07 am

Follow up:

1. I was referring to either state income taxes (if applicable) or business taxes.

2. Touche! But that can be a timing issue. I’m not sure how far in advance you do a BK search before purchasing the lien, but if it was say one week before and afterwards they filed, that was kind of the scenario I had in mind. I guess more than anything I was curious about the repercussions to the investor – appreciate you checking further.

The largest hurdle I’ve found to tax lien investing has always been finding the liens themselves. It seems like some secret society. I’ve paid for services that supposedly give you lists, but those I quickly learned were gone before you got them. If you live out of state, trying to deal with the online systems or county personnel was equally frustrating, and seemed to be mostly land and not homes. I’d love an article on how you go about finding valid liens. Thanks, Ankit!

Reply

Ankit Duggal January 1, 2014 at 11:29 am

1. State (income and business) taxes would be another lien against all assets owned by the owner. The property tax lien would still be superior

2. We usually do the search about two weeks before auction date and do ongoing review on liens that we own. Typically when BK is filed then an automatic stay goes into affect against debtors. However, tax lien have an exception to the stay provision based on my review of the BK code.

“The automatic stay does not apply to tax liens if:
the lien is a property tax lien for taxes due after the bankruptcy filing, or
the lien is for taxes that you cannot discharge in the bankruptcy and the property to which the liens attach is either exempt from the bankruptcy estate or abandoned by the bankruptcy trustee and returned to the debtor

Example. Lois owns a house. At the time she files bankruptcy, she owes $5,000 in property taxes for the year, although the due date for her to pay the taxes is several weeks away. The city will have a lien on Lois’ house if she does not pay the taxes on time, despite the automatic stay.”

You can read more here: http://www.nolo.com/legal-encyclopedia/does-bankruptcys-automatic-stay-apply-tax-liens.html

Sharon Tzib January 1, 2014 at 11:49 am

Very helpful, Ankit! I’ll look forward to more articles from you on this topic. Thanks for the follow up.

Steve Johnson December 31, 2013 at 3:37 pm

Awesome cheat sheet! That’s a very helpful and simple way to explain the many risks of tax lien investing the gurus don’t mention. Do you do all these checks with every single property? For instance, consider Detroit. They have plans to demo entire city blocks but when that happens could be way out in the distant future if at all. There are soo many to demo that I wonder if you should take the cities word with a grain of salt. AND if a property is to be demolished what is going to get the owner to continue to pay up? Anything?

Thanks for the article!

Reply

Ankit Duggal December 31, 2013 at 5:48 pm

Steve

I do the checks for the liens that I want to buy. It is a pain staking process, but investing is not easy. In terms of Detroit type tax lien investment market, I would recommend them only for lien to own strategy buyers but not lien to redemption strategy oriented buyers.

Reply

Gerald Harris January 1, 2014 at 12:00 am

Years ago I was extremely interested in tax liens and saw it as another “quiver in the arrow” of real estate investing. Yes! this can be an extremely profitable niche, but you have to study and and do your homework. Don’t think you can buy a course and that will teach you all the ins and outs of real estate tax liens. 2 months ago I tried to purchase a house a house from a gentleman who invests in Tax Liens. This guy took a picture of the 2 bedroom house that he bought in a tax lien sale for 6k. The property was free and clear but had a tax lien against it. I found the address of the house and ran comps. the Property has an ARV of about 30k. Good deal right? Wrong! the property looks like it needs about 25k in work to be done. You really have to understand what you are doing. people think because you are buying a low end property for a cheap price you are getting a great deal. You must look at the entire picture.

Reply

Ankit Duggal January 1, 2014 at 9:44 am

Great point Gerald. Research and due diligence is the critical step needed to help mitigate bad investments in one’s investment portfolio.

Reply

Greg January 2, 2014 at 5:02 pm

I love my tax liens. Made some really good money in 2013 with all the liens that redeemed!!! I love getting checks in the mail! That is what motivated me to do more!!

Reply

Ankit Duggal January 3, 2014 at 4:28 pm

I love checks in the mail myself. I just hate when municipality tax collector take longer than needed time to process your return payments sometimes. Congrats on a great 2013 of tax lien and may 2014 blow that out of the water.

Happy Investing!

Reply

Shaun January 3, 2014 at 3:48 pm

Does that IRS Code apply to tax sales as well?
In addition to my interest in tax liens I have purchased properties at tax sales and have generally avoided ones with IRS liens.
If what you said is the case it seems that the risk is pretty minimal.

Reply

Ankit Duggal January 3, 2014 at 4:30 pm

The IRS code applies to all tax liens wether sold via auction or over the counter. I have never purchased tax deeds but I hear that you can make good money with them as well.

Happy Investing!

Reply

Shaun January 3, 2014 at 6:49 pm

This is great to know.
My mentor in the area we are doing tax sales just told us to not go for any property with an IRS lien and I just kind of took it at face value.
If the worst that can happen is I will get what I paid back, plus the sales costs and 6% interest from the time of purchase with a max hold of 120 days that is pretty riskless other than a less stellar return.
This will help quite a bit with Due Diligence.
Thanks!

Reply

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