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Property tax basics

Homeowner or not, you’re likely familiar with the idea of property taxes. Governments tax property owners to fund benefits and services for the “common good” of the community. Property tax is in addition to income and sales tax.

Property tax revenue typically provides services like police protection, public libraries, recreation centers, roads, schools, and snow removal. Even fireworks displays.

If you have a mortgage on your home, it’s likely that your monthly payment includes funds to pay your property taxes. Your lender holds the money in escrow and pays the taxes on your behalf directly to the county when due.

You might not know how much you’re paying in real estate property taxes. But rest assured you're paying them if you own a home. All counties collect some sort of personal property tax.

Individual parcels of real estate are valued based on location and features. Each property is given a “tax assessment” value. The owner of the parcel pays a tax on the assessed value. In 2021, the rates by state ranged from a low of 0.28% in Hawaii to a high of 2.49% in New Jersey.

The average property tax rate for single-family homes in the largest city of each U.S. state hovers around 1.5%. The average American household spends $2,149 on property taxes for their homes each year, according to the U.S. Census Bureau.

The county in which the property is located typically collects property tax. If the owner of the property fails to pay the tax, the amount of the tax becomes a lien against the property.

A lien against the property, however, does not help county and local governments pay for the services and benefits they have promised to their citizens. The county needs the money now to fulfill its budget obligations. The government doesn’t take IOUs!

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What exactly is a tax lien certificate?

While the process differs across the country, local governments are authorized to collect unpaid taxes by selling a tax lien certificate or a tax deed at a public auction. About half of the 50 states sell tax lien certificates. The other half sells tax lien deeds or redeemable deeds. The latter is a hybrid between a certificate and deed. Some states sell both tax liens and tax deeds.

There are important differences between the two. Typically you’d buy a tax lien certificate because you want interest. If the homeowner does not redeem it, you might get the property. With a tax deed, you’re buying the property outright.

One is not better than the other. Each has advantages depending on your investment objectives. Each has its own set of rules, and research is necessary. Of course, you can do both simultaneously.

This article will focus on tax liens and leave tax deeds for another time.

The ease of investing in tax liens

What’s nice is you do not need a real estate license. You don’t need to set up an LLC. And you don’t need a lot of money to invest in certificates or deeds.

When you buy a tax lien, you basically paid the taxes for the homeowner in exchange for a certificate. The certificate is good for the amount you paid plus interest.

Also nice is your investment is backed by the collateral of the property or state laws that mandate the redemption of the tax lien, including interest and penalties. As an investor, you’re stepping in to pay the back taxes and locking in a guaranteed interest rate on your investment.

A tax lien certificate is a negotiable instrument. But there is no secondary market, except perhaps eBay and the like.

The certificate is evidence the holder has purchased an enforceable interest-earning lien on the real property. It’s a legal obligation to a first-position lien on a particular property. This means it is the first debt obligation that’s paid out if the property goes through foreclosure.

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The (big) benefits of tax lien certificate investing

When you purchase a tax lien certificate, you’re not buying the property. Nor do you have to deal with the property owner. You’re simply stepping in to pay the delinquent taxes to the county government.

In exchange for putting up the money, the county will give you the interest rate and late fees they charge the owner when the taxes are finally paid. If the property owner does not pay the taxes, you can foreclose and take the title on the property for the total of the back taxes, penalties and fees owed the county.

In other words, there are two investment outcomes from tax lien investing:

  1. The tax lien certificate is redeemed and you earn a secured high-interest rate.
  2. The tax lien certificate is not redeemed and you can acquire the property through foreclosure, sometimes for pennies on the dollar.

Depending on your investing goals, either outcome can be attractive.

Tax liens provide a fixed interest rate, which varies by county. In Baltimore, the interest rate is 12% annually. In other counties across the nation, it can be much lower or much higher. A few counties in Illinois post an interest rate of 18% every six months, which equates to a bit more than 36% annually.

However, as you might imagine, these high rates of return attract a lot of attention. While you don’t need a lot of money to invest, competitors with deep pockets can jump in and bid up the price, squeezing out the small investor.

The price can easily, and often does, escalate above the taxes due. I’ve read that in some counties, properties can sell at a tax auction for more than the property is worth.

Especially if you're an accredited investor, there are a few alternatives that can also yield double-digit annual returns. One example is Origin Investments, which is a private equity firm that allows high-net-worth individuals to invest in diversified real estate funds.

There’s no limit on how much you can invest

You can invest a little or a lot. Tax liens are not like bank accounts that are insured by the FDIC up to a certain limit. There’s no cap on how much you can invest in tax lien certificates.

The property owner maintains ownership of the property. He or she has the right to redeem — pay off — the tax lien certificate until the circuit court judge signs a decree authorizing foreclosure procedures.

As the tax lien certificate holder, you need to initiate the foreclosure process within a certain amount of time, typically two years. If the certificate has not been redeemed and you don’t start foreclosure in time, your investment will be forfeited and no refund will be issued.

How to bid

Most counties hold a tax lien sale annually. Most auctions are conducted online. In Baltimore, where I live, the county sale is held in June, and the city sale is held mid-May.

You register a few weeks ahead of the actual sale and pay a registration fee. (In Baltimore, the fee is $100.) They email you a bid identification number. When the auction opens, you bid on the certificates that interest you via an online form.

The minimum bid necessary to purchase a tax lien certificate includes gross tax, penalties, and interest. The penalties include any applicable costs pertaining to the tax lien certificate sale. The minimum bid is listed beside the delinquent property address and ID number.

So how does it work?

The process of investing in tax liens or deeds is not passive. In fact, it can take a lot of time.

Counties typically publish a list a few weeks before the tax lien sale. There might be hundreds of properties available. You need a system to narrow down the list and decide which ones you want to bid on.

Basically, you need to eliminate those that don’t fit your investing criteria. Start with your own initial investment budget. If you have only a few thousand or even only a few hundred dollars to invest, you can immediately eliminate the properties with higher minimum bids.

If you want interest income and don’t have the goal of acquiring property, look for single-family homes with a mortgage. They offer the best chance of being redeemed. In many countries, their redemption rate is 95% or higher.

The time frame for tax lien investing is between six months and three years. There is no secondary market in which to sell your certificates. So you need to make sure you invest only money you won’t need in the short term.

There are no commissions to pay. But as mentioned earlier, you will likely have to pay a one-time registration fee for the auction.

Make sure to do your due diligence

Due diligence is a must. You might end up foreclosing on a property. You’re going to want to do a drive-by and look at the properties. You will also want to carefully do your online research to complete your due diligence.

You likely will not be able to inspect the inside of the property, as homeowners are unlikely to allow you to drop by and have a look. Still, you will want to know as much as you can about the property, the neighborhood, and the area in general. You don’t want to get stuck with a property that has no potential.

Several tax liens may be purchased on the same property for subsequent tax years. It depends on how long the redemption period is.

For example, in a state that has a three-year redemption period, three tax liens, one for each year, may be purchased. These liens could be purchased by the same investor or by different ones. This means more capital may be required by you as the process moves forward.

When the property is redeemed, regardless of how many investors have purchased tax liens, all tax liens and interest are paid. If the lien does not get redeemed then there would be a foreclosure process as per the county and state statutes.

If your objective is to foreclose and acquire the property, you might need to purchase any subsequent liens, because sometimes, newer tax liens take precedence over old liens. Whoever forecloses on the property to take the deed may also be responsible to pay all other tax lien holders.

Learn more

There are books, seminars, and courses on the subject. And as mentioned earlier, each county has its own set of rules governing the process, the redemption period, rates of return, and the bidding process itself.

This article is intended as an overview. You can and must study the market and make sure you understand the particulars of your intended market before you make a bid.

As an investor, I’m constantly looking for new opportunities and evaluating risk vs. reward. On June 2, Baltimore County will hold its annual tax lien certificate auction.

I’ve registered for the online sale and received the list of properties to be auctioned. Right now the list contains several thousand properties but will likely shorten before the actual sale as property owners pay their taxes.

I am doing drive-by visits now to carefully select a few tax lien certificates I’d like to bid on. I’ll follow up with an article on my experience in the coming months.


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About the Author

Ruth Lyons

Ruth Lyons

Freelance Contributor

Ruth Lyon is a freelance contributor for Moneywise.

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