Tax Liens

  • Q: What is a Tax Lien?

    A: A tax lien is a judgment against a property.  In other words it is someone's unpaid debt that can be bought by a private individual.

    Q: Why would I buy someone's debt?

    A: Well, because it is a "collateralized debt obligation" which basically means that they WILL repay it or they will lose the property they put up as collateral.  Also, most states guarantee a high rate of return, in many cases 10% is guaranteed.  If the owner does not pay their tax bill, you may foreclose upon the property and own it outright even if there was a mortgage or other outstanding debts secured by the property.  So in other words, you either get your money plus 10% (guaranteed by the State) or in some cases you get the property outright.

    Q: Why haven't I heard of this before?

    A: Investment advisors do not market lax liens because they can not charge a commission on them.  They must also be purchased directly by the owner and not by an agent of the owner (your broker, or financial planner).

    Q: If people can get 10% interest on their money, why do they put it in banks for less than 1.5% interest?

    A: You will have to ask them.  However there are some drawbacks, including time, liquidity, and management.

    Q: Can you explain EVERY possible drawback.

    A: Sure:

    1. Tax liens are not liquid and can tie your money up for as many as three years.  You don't exactly know when the owner will pay his taxes and thus you can't tell how long you will collect the prorated 10%.  Three years is the maximum at which point the property becomes yours free and clear even if it had prior mortgages or judgments against it.

    2. Tax liens require that you communicate with the county where the property is located.  You need to get the list of delinquent taxes from them, then select a property that has more value than it owes (I suggest residential homes in a good neighborhood), then you notify the county that you would like to buy the property, then you send a registered letter to the property owner (it has to be an exact copy of the form letter that the county uses) and a check to the county.  The owner now has 15 days to pay the taxes, if they do your check is returned (a downside as your money is not earning during this time).  If they don't pay then the county sends you a copy of the deed and other paperwork that must be held until the lien is paid, or you foreclose.  As you can see, its NOT as simple as buying a CD at the bank.  The paperwork, organization and knowledge necessary represent a significant obstacle to tax lien investing.

    3. If you just select properties without doing "due diligence" (basically you do some checking) you might get a property that no one wants.  Sometimes a sliver of useless land has its taxes unpaid because the owner doesn't want it.  If you pay the lien on a property like this, you will get the property and will be unable to sell it.  That is why I suggest properties in good neighborhoods.  Also, if you invest in commercial property liens there are potential dangers.  Commercial taxes are a higher percentage of value than residential, meaning that the ability to foreclose upon a property will yield less (or none) in profits. If you invest in a gas station's (20k) tax lien on its 100k value you might find out that its tanks are leaking and will need to be dug up and an environmental cleanup done. This is a disaster best avoided by investing in residential property. Residential property can easily be sold to an investor or you can list it with a local realtor.

    4. Another drawback is that New York is not among the best and most favorable states for tax lien investing. I suggest you look at each and every state as the laws and procedures regarding these investments differ. Most investors say that Montana provides the most straight forward laws and procedures and I suggest you begin investing there.