Tax Lien Investing: 5 Important Risks to Consider

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Wonder how tax lien investing works?

Local governments generally collect a majority of their revenues from taxes on real estate. These property taxes fund all sorts of government operations, from police to parks to schools. Therefore, local governments really want those property taxes to be paid. If property owners fail to pay their property taxes, various states provide methods for local governments to get what they are owed.

Depending on the state, a local government may place a tax lien on a property. This can then be sold to a private investor. Or they can take the property and sell it outright through a tax deed sale. Tax liens and tax deeds are both generally sold at a public auction and can present great investment opportunities.

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Tax Lien Investing: 5 Risks to Consider

Investing in a tax lien or tax deed may sound easy. You go to an auction, buy a lien or deed, and then collect interest on the lien or take title to the property. An investor can get some really good returns (as high as 18%) or get a property for pennies on the dollar. But those fantastic returns do not come without risk. There is a reason why the returns can be so good, and that is because there could be a considerable amount of risk.

Related: 3 Common Tax Strategy Myths Taught to Investors at Educational Seminars

Here are five things you should carefully consider before investing in tax liens or tax deeds.

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The underlying real estate may be worthless.

Or it may be almost worthless. That tax deed property you picked up in Tennessee may be a sliver of land 3 feet wide by 10 feet long. What are you going to do with that? That tax lien you picked up in Florida might be located in the Everglades and have a perpetual flood easement over it.

No wonder these property owners stopped paying the taxes on them. They did not want them and neither should you. In fact, now that you own them, you have incurred liability and have to pay to maintain them. Do your due diligence and know what you are getting into. There are reasons some properties have been on the tax sale books for decades.

The underlying property may not be maintained.

Property owners that get in to arrears with their property taxes often have few resources to maintain their properties or have no desire to do so. Remember with a tax lien you do not actually get title to the property, just a lien on it. The owner may take what you thought would be a nice little income property and let it crumble into the ground. With a tax sale property, the original owner usually has a redemption period where they can pay you for the taxes owned plus interest and get the property back.

What if a tree falls through that property during that time and the owner either cannot or will not fix it? Guess who that will fall on? You. How much do you want to spend on a property you do not own yet? Code enforcement can also be a real pain here. They may levy fines for a whole host of problems, from tall grass to broken windows. I have even heard of folks buying properties or liens and then going by the property a month later only to find out the property was condemned and torn down by the city. Now what are you going to do with that vacant lot? Again, know and research what you are getting into.

The government makes mistakes.

Hard to believe, I know, but they do. Some can be really big ones. Imagine buying a property at tax sale only to find out that the government did not notify the proper owners they were taking it. Now you are stuck in the middle of a lengthy court battle. Or the government can declare you tax lien in error and take it back with only a 0.5% interest rate. Not quite the return you expected to get, is it? Be sure and ask to see all the records the government has related to the property. Do your own title search to make sure the right people were notified. It can save you a lot of trouble later on.

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Related: The Ultimate Guide to Real Estate Investment Tax Benefits

Laws and politics change.

All it takes sometimes is one story about an old lady getting thrown in the street by a “greedy” real estate investor to have a world of hurt come down. You may have every right to do what you do and also have the law on your side. But that does not mean that an elected judge or official is going to side with you and throw old ladies into the street, so to speak. Plus, the recent foreclosure crisis has heightened awareness of these issues. There’s not much you can do when politics are going against you, but make sure everything you do is proper and legal while understanding the risk.

Bankruptcy law varies.

Bankruptcy law varies from state to state, just as the methods for dealing with delinquent property taxes do. If a property owner declares bankruptcy, that could potentially delay or crimp your investment. A bankruptcy could reduce the amount of interest on a lien or alter the payment schedule. They could also delay a planned tax sale. Again, the recent foreclosure crisis has heightened awareness of these issues, and some judges are taking more active roles in these matters.

All in all, tax liens and tax deeds can be great real estate investments. However, savvy real estate investors perform significant due diligence and know the risks of what they are getting into. If you plan to purchase either of these two items as a part of your real estate portfolio, you should as well.

Have you tried out tax lien investing? Anything you’d add to this list?

Leave your questions and comments below!

About Author

Kevin Perk

Kevin Perk is co-founder of Kevron Properties, LLC with his wife Terron and has been involved in real estate investing for 10 years. Kevin invests in and manages rental properties in Memphis, TN and is a past president and vice-president of the local REIA group, the Memphis Investors Group.

15 Comments

  1. Vania Castillo

    Hi Kevin,

    I have some experience investing in tax liens and have navigated through most of the risks you mentioned.

    Likely, I’m familiar with the city where I invest and the time to redemption is only 12 months. Most places have a longer time period before the owner has to redeem which is not fund since forces the investor to keep up with subsequent taxes in order to keep the position of seniority and have the possibility to redeem at some point.

    • Kevin Perk

      Alex,

      For you, impossible. 🙂

      For everyone else it will depend on how well the government did their job in notifying the proper owners that they were taking their property for unpaid taxes. Sometimes they do a good job, sometimes not.

      So you might get a good title, but because these things are often processed incorrectly title insurers are wary of giving title insurance for them, which poses a whole host of other problems. Again, know and understand what you are getting into. Do not trust what the government says. Review the government documents and do your own title search.

      As always, thanks for reading and commenting,

      Kevin

  2. I’m just beginning to try to understand tax lien sales, so forgive my newbie questions. 🙂 If there is an existing mortgage on the property, does that follow the property? And what about other liens: mechanical, medical and the like?

    • Kevin Perk

      Sandy,

      Thanks for reading and thanks for the questions. I wish I had a clear answer for you but I do not. That is because it is going to depend on the state you are in and their particular laws. A tax lien is usually going to rise to the top so to speak but I cannot say that for sure in all cases. A tax sale and tax deed will generally wipe out a mortgage. But every situation may be a bit different.

      Your best bet is to find someone in your local who can show you the ropes.

      Good luck!

      Kevin

  3. Mike hoherchak

    From my understanding. You can get a clear title with no other liens or encumbrances. But each state is different and also each county within that state is different regarding laws and such.

    But generally speaking, you have lien states and deed states. What that means, is if you’re in Texas, for example, it’s considered a lien state. If you buy a past due tax lien, there is a 3 years waiting period before you can foreclose on the property. But you also have to purchase the past due liens from years 2 and 1 (or any other past due years) before doing so, also, to get the property current on taxes. A clean title here, like you said, can be impossible.

    Contrast Texas, with Pennsylvania, which is considered a deed state. What that means is that the county holds the past due tax liens for the 3 year grace period. So instead of purchasing a lien, you are purchasing a deed to a property. In PA, you can do this at a sheriff’s sale that happens throughout the year, clear title not guaranteed. Or you can purchase at a judicial auction sale that happens once or twice a year. This is where you will get a clear title with no liens or encumbrances. At least to the best of my knowledge.

    • Kevin Perk

      Mike,

      Good info, thanks for sharing.

      Reinforces the fact that things are different from state to state and even county to county. Find someone local who can help show you how things work in your location.

      Thanks for reading and commenting,

      Kevin

  4. Larry Weingarten

    Hello Kevin, I’ve been involved in tax deed sales for some years and it’s been a good thing. Now I’m finding that title companies are no longer willing to insure properties a year after they have “settled”. I’m hearing that you may need to wait five to twenty years before a title company will provide insurance. So, this means the added cost of quiet title or going to a tax title service. Have you experienced or heard of this new trend?

    Yours, Larry

    • Kevin Perk

      Larry,

      Yes I have. I have had to “work some things out” to get title insurance. It cost a little time and money but things did work out. Title companies are cautious when it comes to tax sale properties.

      Thanks for reading and commenting,

      Kevin

  5. roy Oliphant

    Great info! So many of the sites are promoting this as a “Guaranteed” near-effortless way to get into REI; Step 1, buy the lien. Step 2 wait for the check including your 18-35% interest. We know there are many times when that check will never arrive. And then you may be a remote property owner of a property you don’t want and cant sell! I’m glad there are some investors looking for those opportunities who can help people stuck with these liens.

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