People invest in tax liens for myriad reasons, but a primary reason for investment in others’ delinquent property taxes is the fact that a tax certificate or lien can be purchased for an average of several hundred dollars. Compared to the several thousand dollars needed to get into most investments related to real estate and the reason for the attraction becomes obvious. Should the lien be carried to full term, investors have the opportunity to foreclose on the property itself—potentially quadrupling the initial investment.
What is a tax lien?
A tax lien, or tax certificate, is a taxing unit sold by a governmental agency—usually a county—when a property owner is delinquent on property taxes. If the county needs money immediately to maintain its budget and avoid going through the foreclosure process, it can sell these notes to the public at auction. In this way, the county gets its cash and the lien buyer walks away with a potentially excellent investment.
When purchased, tax liens give the purchaser the right to collect interest, serve notice to foreclose and obtain possession of the property when applicable.
Using self-directed IRA funds for investments
Many proponents of tax lien investing do not know that these certificates can be purchased as a part of an IRA’s investment portfolio. IRS code dictates that the only investments unavailable to an IRA are life insurance and collectibles (e.g., rugs, paintings). This means that tax liens, deeds, private loans and real estate are all possible investments for an IRA holder.
To invest in a tax lien with a retirement account, one needs only the correct account structure. Called “self-directed IRAs” or “real estate IRAs,” these accounts enable IRA account holders to direct their funds into any legitimate IRA investment, including tax liens.
Finding tax liens
To invest in a tax lien, one mus first determine where tax liens are sold. While many counties and states offer tax liens, there are several that only offer tax deeds, which are an altogether different kind of investment.
Once an investor determines that a county offers tax liens, the next step is to do research on the properties offered. As with any investment, prospective investors will want to determine if the risk is worth the reward. Many counties have websites that list the properties being offered at auction, property information and sometimes photos of the estate up for auction.
While most liens are sold at live auction, some states and counties are beginning to sell liens online. An online search on “tax liens” plus the area of consideration will most likely yield the information needed.
Bidding on tax liens
To bid on a lien, investors bid down from the guaranteed interest rate to the state or county when the taxes are eventually paid. For example, if the county charges 15 percent interest on delinquent taxes, an investor can bid down from 15. Let’s say the investor bids down to 12 percent and wins the bid. This means that when the taxes are paid, the investor receives the principal, plus 12 percent interest. The extra 3 percent interest (15 – 12 =3) is paid to the county.
Paying for tax liens with IRAs
Because the purpose of these auctions is to get money fast, the county or state will expect payment immediately or up to 48 hours after sale. This is where it can get difficult if the investor has a traditional self-directed IRA. Because traditional self-directed IRA accounts are held with a custodian, the investment must go through an approval process before a check is cut. When this is the case, many investors with self-directed IRA custodial accounts cannot make investments in tax liens because they are unable to access their funds fast enough to secure the lien.
To circumvent this situation, some investors may be able to direct the money they plan to invest in the lien into an escrow account. Several weeks prior to the auction, the investor must determine the amount he or she is willing to spend on a lien. The investor then directs the custodian to fund the escrow account in the amount previously determined.
There is another way, however. Some self-directed IRA accounts are setup using a customized Limited Liability Company (LLC). By adding on this entity, the account holder gains “checkbook control” of their account, meaning they can write checks directly from the LLC bank account to their investment. If the tax lien investor has a self-directed IRA LLC account, he or she can simply write a check, or obtain a cashier’s check from the bank, on the day of the auction for any liens won.
Holding the tax lien
Once the lien is obtained, the account holder needs only to wait until the delinquent taxes are paid. If the taxes are not paid, however, the investor would receive first right of refusal for the next year’s delinquent taxes. In most counties, the tax payer must suffer three years of delinquencies before the investor has the right to foreclose—meaning, the lien holder must pay three years of past-due taxes before he or she can see a return on their investment.
Should the tax payer default on their taxes for the full three years, the investor then has the right to take possession of the property through foreclosure—oftentimes creating a phenomenal return on their initial investment.
A leading expert in self-directed IRA investing, David Nilssen is the co-founder and CEO of Guidant Financial Group, Inc., of Bellevue, Wash. Guidant's services enable account holders to direct retirement monies into traditional and alternative investments. A strong believer in broad diversification and hands-on investing, Nilssen pioneered the concept of “one-stop shopping” within the self-directed IRA industry.
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