As foreclosures continue to pile up, so do unpaid property taxes. That’s an opportunity if you’re willing to wade into the arcane world of property tax lien sales. Before you do, however, understand the risks that come with these little-known investments.
“Every year, $7 to $10 billion in property taxes go delinquent,” says Howard Liggett, executive director of the National Tax Lien Association in Pensacola, Fla., a trade association of investors, tax collectors, and service providers involved in tax lien sales. “The subprime mortgage crisis has spiked those numbers. For example, four of the 67 counties in Florida saw spikes of 30 percent to 33 percent in the number of tax liens offered for sale last year.”
Homes on the auction block
Tax collectors in 29 states, Washington, D.C., Puerto Rico and the U.S. Virgin Islands use tax lien sales to force owners to pay unpaid property taxes.
“It’s a method for people responsible for collecting property taxes to make everyone pay their fair share,” says James Hughes, president of SRI Inc. in Indianapolis, who’s represented governments in tax lien sales for 20 years. “If there were no enforcement, nobody would pay their property taxes.”
The process varies by state, but here’s how it generally works: When property owners don’t pony up for their property taxes, tax collectors wait the time period required by state law and then put those unpaid property taxes up for auction.
“The time period varies from just a few months to several years,” says Hughes. “In Florida, if owners don’t pay taxes due in April, tax collectors will sell a lien June 1. In Indiana, it’s about 15 months before a property goes to a tax sale.”
In most states, the person willing to pay the most cash for the tax lien wins the auction. Some states, however, have a bid-down process, where investors’ bids indicate how much interest they’re willing to accept on their investment, and the lowest bidder wins. Whatever method is used, the tax collector takes the payment for the overdue taxes from the winning bid. In exchange, the purchaser gets a lien on the property.
As the winning bidder, you’d get a return on your investment in one of two ways: interest on your bid amount, or ownership of the property.
1. Interest on your bid amount. If owners redeem their property by paying the overdue taxes within the time allowed under state law, you’ll get your investment capital back, plus the amount of interest allowed in your state.
“Tax lien sales are good investments because they usually have a statutory interest rate, typically between 10 and 12 percent,” says Walter Spader, an attorney at the Marcus Law Firm in North Branford, Conn., who represents tax lien purchasers. They can go much higher, too. For example, Connecticut offers 18 percent, and Nebraska offers 14 percent.
Assume Joe Smith, an Indiana homeowner, owes $500 in unpaid property taxes. Your $5,000 offer is the winning bid at the auction. If Smith redeems his property within a year, as required under Indiana law, he’ll owe the tax collector the initial $500, plus a 10 percent penalty, totaling $550. He’ll also be required to pay 10 percent interest on the amount of the bid over the initial tax bill, or $450. As the winning bidder, you’ll get your capital investment of $5,000 back, plus that 10 percent interest payment of $450.
2. Ownership of the property. About 75 percent of owners redeem their property within a year. However, if owners fail to redeem their property, you’ll have to file a lawsuit seeking title to the property. That process can be complicated, costly and time-consuming, but once it’s complete, you take ownership.
Avoid the pitfalls of tax lien sales
What’s the catch? There’s no catch, but there are pitfalls to investing in tax liens. Here are four tips for avoiding them.
1. Scope out the property. “Make sure there’s a house on the property and that it’s still there when you bid,” says Hughes, “The house could burn down or be damaged by something like a flood. If you paid $5,000 and the land is worth only $2,000 after the home burns down, you’ll lose money. That doesn’t happen very often, but it has happened.”
2. Check the records. Spend time at your local tax collector’s office combing through the records.
“Make sure the municipality followed all statutory procedures in placing the tax and the lien on the property,” says Spader. “Look at what’s on the land records. Did the tax notice actually go out? Were there partial payments that may not have been applied?”
3. Monitor your investment. If your state allows a long redemption period, protect your investment.
“If there’s a two- to three-year redemption period, when next year’s taxes are due, pay them and get another lien,” says Spader. “If you don’t also pay the next year’s taxes, the municipality can lien that property again, another person could buy that lien, and then you’d be in trouble.”
4. Be patient. “The return on your investment can be delayed for extended periods of time,” says Liggett. “For instance, owners could file for bankruptcy, which may allow them more time to redeem the property.” A bankruptcy could also mean a lower interest rate, since bankruptcy judges are sometimes permitted to lower debtors’ interest rates to help them get back on their feet.
Start small and local
If you’re interested in tax lien sales, do your legwork first.
“Go to the revenue officer charged with property tax enforcement,” says Liggett. “Find out when sales are held, how they’re conducted and how you’d participate. All that information is free because it’s public record.”
Then troll in your neighborhood pond. “Stay local and take advantage of being a little guy,” says Spader. “Since you know local properties, you can better tell their value. Also, smaller towns don’t have as many liens available, so you’re less likely to be competing with big investors looking to buy portfolios of tax liens. You may even be able to go right to an individual government official and find liens that aren’t being offered in a public auction.”
Even if you’re not sold on tax liens as an investment vehicle, they serve as a stark reminder to all property owners. “Pay your property taxes,” says Hughes. “The penalty is too great to not pay them.”
G.M. Filisko is a writer in Chicago.