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 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:
|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:
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.
Photo Credit: K.Wiklund