One-Stop Place for Tax Lien Questions and Answers
1. Tax Lien 101
A lien by definition is a claim against an item, it affects the item owner's ability to transfer ownership to another party, the lien owner can utilize that item as security for repayment of a loan, or other claims.
Property taxes are also called ad valorem taxes, and are defined as county assessed taxes on real property within the county boundaries.
Every piece of real estate - vacant law, raw land, or land with buildings on it - is subject to property taxes . The tax rate for each property is based on a combination of property value and the county’s estimated budget for the year. Note the assessed value of a home is almost always different from the fair market value.
The county uses those property taxes to fund things like the fire department, police department, road signs, streets, development projects, schools, teachers' salaries, etc. Because the county governments need property taxes to pay for these things, when they have difficulty in collecting property taxes, it creates an investment product - tax lien.
Many property owners just pay their property taxes along with their mortgages; but sometimes the property owner doesn’t have a mortgage or maybe the owner passed away, this creates a chance that the property owner fails to pay for those property taxes before the due date. Instead of raising taxes for those that actually pay taxes, the county places a tax lien on the property. The tax lien affects the ability to transfer ownership to another party. After the tax lien is issued it gives the county the ability to collect the debt in another way, through tax lien certificates.
The county issues the tax lien certificate and then announces the sale of the certificate (as expected, different counties have different dates for such sales). Whoever owns the certificate will have guaranteed interest on investment by the county government!
State and Tax Liens
The collection of property taxes is done by municipalities and is governed by the state, each state is free to set their own rules as to how they will sell and reward the buyer of each tax lien certificate, with a few federal laws that bind the states. Over all the states can do whatever they want, this means each state is different and requires specific understanding.
To the credit of the states, they are very similar in what they reward and how they function. The tax lien investment strategy is pretty consistent from state to state with only small differences. For example, different states will give higher percentage rates to the investor or longer redemption periods for the property owner.
The county holds the tax sale and investors show up to buy the tax lien certificate. The investors want the interest that is promised by the government for that certificate. The auctioneer presents the certificate to the investors and those investors that are interested in the certificate bid on the certificate (more explanations on the bidding later), and the winner walks home with the certificate.
In short, the investors didn’t pay the taxes for the property owner, the investors simply purchased a certificate in the same amount that the property owner owed to the county. The investor doesn’t own the property at this time; he or she only owns the certificate. However, the investor may have the right to take ownership after the redemption period ends if the property owner doesn’t pay his or her taxes.
Using Florida As An Example
In Florida, the interest rate is 18% and redemption period is 2 years. When the investor buys the certificate the interest immediately begins to accrue. The investor starts making money on the investment right away. Unlike stocks or any other investment you don’t have to sit and watch and worry about whether values are rising or dropping and whether you’re making or losing money every day. With tax liens you know that every day you’re making money and you can calculate the money you’re making every day.
Now back to the above example. To remove the tax lien from the property, the property owner has to pay his or her property taxes to the county (note, not to the investor). In fact, the property owner doesn’t even know the investor exists. The property owner is also required to pay a penalty for being late.
When the county receives the payment from the property owner, it writes a check to the investor (owner of the tax lien certificate) for the amount of the taxes plus the agreed interest by the investor through the auction.
But what if the property owner never pays the property tax amount?
If for whatever reason the property owner doesn’t pay during the two-year redemption period, that's when the real fun starts.
The tax lien certificate that the investor bought in the auction gives the investor the right to take ownership of the property through foreclosure. Of course you have to follow the foreclosure procedure in the county, but after foreclosure, the investor owns the property - at the price paid during the auction, which is just the tax owed to the county, typically much less than the actual property's market value.
So with tax liens you either get your investment plus a high interest rate like 18% or you get the property.
It’s a Win/Win/Win. The county get the money they need to operate. The property owner gets a redemption period to pay their taxes, and the investor gets a great guaranteed return.
What are the Complications of Tax Lien Investing?
There are quite a few complications could happen, and as an investor, you need to be prepared for any of such complications.
What if there are multiple tax lien certificate owners?
This is possible, for example, the property owner hasn't paid taxes for 2008, 2009, 2010, 2011, and 2012, which resulted in multiple investors own different years' tax lien certificates.
Does it make a difference, if you are the 2008 tax lien certificate holder, the 2010 tax lien certificate holder, or the 2012 tax lien certificate holder?
What if the bank also owns a lien against this property?
If the property owner (mortgage borrower) hasn't been paying mortgages, the bank could have a lien on the property too. As a tax lien certificate owner, do you have to pay the bank's mortgage balance first before start the foreclosure process?
What if there are IRS liens on the property, who has priority on the property?
What if you won the auction by bidding at an interest rate of 6%, not the 18% the property owner pays to the county government?
Now the property owner pays the county back with the 18% interest, do you get the 18% return, or just 6% return?
2. Government and Officers' Roles
The Federal Government
The Federal government is funded primarily through income taxes and won’t play too large of a role in tax lien investing. In some rare cases, IRS maybe a lien holder on the property, which it will get first priority over other investors.
The State Government
The state government gets its revenues mainly from income taxes and state sales taxes, not property taxes. However, the state government is important to tax lien investing because it determines how tax sales will operate inside the state.
In most cases, the state government determines the system used - tax liens, tax deeds, redemption deeds, or any combination of them. The state will determine when the sales will occur during the year, and the sales procedures - bidding down the interest rate, premium bidding method, or another bidding method?
The County Government
The county government primarily gets their money from property taxes and from the tax sale system, it is the largest stakeholder in tax lien investing.
Elected officials manage the county government and each plays a role in the tax sale process. Some of the important players are the commissioner, the sheriff, the property assessor, and the treasurer.
The treasurer or tax collector will typically be an investor's primary point of contact at the county, but the assessor can also provide information about investments. The sheriff is sometimes responsible for the actual tax sale. In that case, the tax sale is also referred to as a sheriff’s sale.
The County Treasurer or Tax Collector
The County Treasurer’s duty is to receive and safely keep the revenues of all public monies of the county. They also invest the surplus funds. They typically oversee the tax sale. They’re also responsible for the taxation of all personal and real properties within the county. They send out the tax notices, delinquency notices, and tax sale notices.
As a tax lien investor, you usually contact the treasurer when you want to buy a tax lien or deed over the counter or to get information about a potential investment.
The treasurer may also be given some leeway from the state with certain things pertaining to the tax sale. For example, they may have power over whether tax liens or deeds are sold after the auction. Some states have fairly loose laws so a conversation with the treasurer or tax collector may clarify a few things.
The County Assessor
The county assessor is in charge of assessing a property’s tax assessed value. They go through and put a value on every piece of real estate within the county. They determine the value by considering both the county’s budget and also the fair market value of the real estate.
But the most important reason why an Assessor is important for a tax lien investor is that property records are typically stored with the county assessor. When you are researching potential investments, the property records will be important information to obtain. On those records you can find images, values, addresses, sales history, property descriptions, etc. And, increasingly, that information is stored online on the county assessor’s website instead of only in paper form at the county office.
How are Properties Assessed?
Properties are assessed using one of three methods: market, cost, or an income approach. Most Assessors use a computer assisted mass appraisal system to evaluate every property in the county, but it's useful to have a basic understanding of each of the assessment methods, you can determine, on your own, the true value of the property.
Fair market value has been defined as the price a willing and informed purchaser would pay to an unrelated, willing and informed seller where neither party is under compulsion to act. A good way to judge that value is by checking the prices of recent sales of comparable properties, also called “comps.”
Some people will use Zillow or other websites to get a quick look at comps or estimated property values. The key word there is estimated. Although Zillow has been know to be right on, it also can be off by quite a bit. So it’s good to get an idea from Zillow, but it shouldn’t be treated as absolute truth.
Cost-based approach starts from the original or replacement cost of a property, then reduce it by an allowance for decline in value (depreciation) of improvements. Replacement cost may be determined by estimates of construction costs.
Using the income approach, value is determined based on present values of expected income streams from the property. This may be used on farmland where crops produce revenues each year. So the assessor may choose to include potential income for that property as a source of property value.