A tax lien becomes available when a property owner fails to pay property taxes. The government then auctions off the tax lien certificate. An investor can buy the certificate and take over the government’s first position creditor status, which puts the investor first in line for payment—even before a mortgage lender.
If the property owner fails to pay the creditors, the property is auctioned off, with the proceeds distributed to each lien holder in turn. The tax lien holder is paid first. Because it is unlikely that a property would sell for less than the lien amount, tax liens tend to be safe investments. Tax liens are attractive because “there’s a good chance that you’re going to get paid,” Joanne Musa of taxlienlady.com said.
Investors are drawn to tax liens because they offer high interest rates and the security of being backed by property. “In the lien states you’re really looking only to put your money to work at a higher rate of interest,” said Darius Barazandeh, a Texas attorney and investment expert of informedinvestor.com.
Liens are popular because they are easy for people who “don’t really want to get into full-time property management,” Barazandeh said. Tax lien investors usually seek a high interest rate for their money at minimal risk rather than the property itself.
Like tax liens, tax deeds become available when property owners don’t pay property taxes. The purpose of a tax deed is recouping lost property taxes to the county. “Some states don’t mess around,” Musa said. “If you don’t pay your taxes, they’re not going to sell a lien on your property. They are going to sell your property.”
In what Barazandeh called a “pure deed state,” the property is auctioned off at a tax sale and the sale is final. “You’re going to get that property outright if it’s a pure deed state, meaning there’s no redemption, there’s no chance for that delinquent property owner to come back,” he said. “You just have the property; you’re buying it right there at the sale.”
Tax deed investors are not looking for a return in the form of an interest rate. Tax deed investors profit from the equity split between the deed price and the property value. This offers the potential for greater returns than with liens. “You can make the most money in tax deeds” because they typically provide a “pretty good equity split” between the price of the deed and the value of the property, Barazandeh said.
Tax deeds are more expensive than tax liens; they are also riskier than liens, because the investor is responsible for performing more in-depth due diligence on the property and its existing liens, physical limitations and market value.
Although each state is classified as either a tax lien state or a tax deed state, there is also a “kind of third tier” that exists in the form of redeemable deeds, Barazandeh said.
Redeemable deed states auction off property deeds, but there is a period during which the delinquent property owner can come back and redeem the property. If a deed is redeemed during that period, it works much like a lien; the property owner must pay what is often a large penalty or interest rate.
If the property owner does not redeem, the deed holder can become the fee simple owner of the property. Different states have different procedures for how this occurs, so investors should research the rules and procedures carefully before taking any action.
Tax Lien Certificate States
Tax Deed States
Redeemable Deed States