Tax Lien Investing: How It Works and Dangers Investors Face

Tax lien investing may appeal to investors with little money looking to get exposure to the real estate sector. As lucrative as it may be, tax lien investing also presents a set of challenges that you should consider before getting into it.

Real estate is among the most exciting sectors to invest in. Aside from the many investment opportunities that you can access, real estate investing can also help make your portfolio more resilient in a recession.

Bill Gates is investing in real estate through farmland purchases. Many investors with little money seek to get real estate exposure through REIT stocks. Tax lien certificates offer an alternative method for small investors to get real estate exposure.

You can consider tax lien investing as a type of debt investment. It involves purchasing property tax debt from the local taxing authority. You make money when the property owner settles the tax debt and interest.

If you own a home, an apartment block, or a commercial building, you’re expected to pay property tax to the local authority. The tax is often levied annually and the revenue goes into funding various public programs such as road maintenance. Those who purchase a property on a mortgage usually have the tax included in their monthly bills. You’ll be responsible for paying the tax directly to your local authority after you pay off the mortgage.

If you default on the property tax, the local authority can put a tax lien on your property. Instead of waiting for you to settle your tax dues, the local authority can sell the tax lien to a private investor to obtain immediate cash. The investor will then pursue you to pay the tax debt to recover their money.

The local authority would first identify properties with overdue taxes. It would then put out liens on those properties. The next step would be to create tax lien certificates to sell to interested investors. In most cases, property tax lien certificates are sold through auctions. Therefore, investors bid for the opportunities. In the auction, the authorities usually seek to recover most of the outstanding property tax amount.

In most places, the property tax is about 1 percent of the property value. Therefore, if a property is valued at $200,000, then the tax bill would be $2,000. If the owner of that property fails to pay their dues, an investor would only need to put in $2,000 to purchase the tax lien certificate on that property. Therefore, you can start investing in real estate through tax liens with modest amounts.

If the tax remains unpaid for a long time, then the tax lien certificate investor may get to possess the property. You have an opportunity to own a property for a price of a few years of overdue taxes.

The first problem with tax lien investing is that certificate auctions are usually very competitive. As a result, you may only have a minimal profit opportunity. Many legal issues can arise in tax lien investing that can make recovering your money difficult. Finally, while you may be able to purchase a property for the price of the overdue property tax, the process is usually complicated.