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."