Why Tax Lien Investing Requires a "Detail" Oriented Person

Tax Lien investing is often pitched as a "simple" way to make money in real estate. It's described as simply paying an owner's past due taxes and then either getting a "guaranteed" high rate of interest in return or getting the property after a certain amount of time passes.

First off, there is no "guarantee". If the person doesn't pay their taxes, you get no return at all. You get to start a foreclosure (which costs more money) and the rules for if or how you get the property from foreclosure varies widely from state to state, and sometimes by county and even city.

You need to be a "detail-oriented" person in tax lien investing because you'll need to learn the nitty-gritty details of statutes surrounding the sale, redemption and foreclosure rules of tax liens (also called tax certificates).

I'm often noted on the Biggerpockets forums for mentioning you basically become a paralegal to read and understand all the laws about tax liens for the area you invest.

So what are some of the details you need to learn about tax lien investing?

The state of Arizona sells real estate tax liens. The taxes that are not paid by owners are auctioned off the next year to investors. The interest rate paid starts at 16% and the rate is bid down by investors, with the winner being the investor who bids the lowest rate.

If the owner does not pay the subsequent year's taxes ("sub taxes") then the investor has the option of paying those taxes and earning the same interest rate as their original lien. This allows the investor to keep their lien in force because the owner of the property has 3 full years to pay back the taxes. If the owner has not paid the taxes after 3 full years from the date of the lien sale, then the investor can begin a tax lien foreclosure to take over the property.

If the investor chooses not to pay the sub taxes, the n the original lien they won is combined with the next year's unpaid taxes and both are sold to a new investor. Thus the original investor is no longer in line to foreclose on the property. The new investor now has both liens and only has to wait 2 years to foreclose.

Simple enough, right? Ahh, wait a minute. That's how it works in most counties in Arizona. However in Maricopa county (Phoenix area), you don't have to pay the sub taxes, but you get to keep the original lien. So you can only buy one year's worth of back taxes, and if it's the first year of unpaid taxes, then you will have the first chance to foreclose in the event the owner never pays.

These are the kinds of little rule changes you need to know if you are investing in tax liens. It can vary widely even in the same state.

Example 2 - Florida 5% penalty. In Florida they refer to them as "tax certificates", you also bid down the rate from 18% in 1/4% increments. Certificates often are bid down to 1/4% interest! But the statutes in Florida state there is a minimum Penalty rate of 5% that the investor earns. So even though the investor bid only 1/4% interest, they can earn a full 5%. Seems clear.

Some certificates aren't sold in the auction. Some counties offer these certificates after the auction to anybody who wants to buy them and you get the full 18% annual interest. Many counties refer to these unsold certificates as "Over-the-Counter" certificates. The interest is earned each month by taking 1/12 of the annual interest. So an 18% certificate earns 1.5% interest each month. A 1/4% annual rate is only .020833333% each month - except don't forget the penalty rate of 5% in total. Well wait a minute here, there is a rule that states that if you buy the Over-the-Counter certificate, you do not get the 5% penalty rate if the owner pays off right after you bought the certificate.

Got it? Yeah, it is confusing. You need to be a detail oriented person to catch all these rules.

Example 3 Florida tax certificate foreclosure. In Florida you can foreclose after 2 years if the owner hasn't paid the taxes. But you file for the county to foreclose and you have to pay off any other tax certificate holders if you did not pay the sub taxes after you bought your first certificate. Then you don't get the property, the county auctions the property and you may have to bid to win it. So not only did you buy the tax certificate, you now paid for the property at auction too. Some of that money you bid goes to pay back your certificate and interest, but you may have to bid higher than the taxes to get the property. If nobody bid at the foreclosure auction, then you have the right to get the property title. But check with the state and county statutes to see exactly what you have to pay and if you get the property if nobody bids at the foreclosure auction.

Example 4 Illinois filing requirements. In Illinois you bid down the interest rate from 18%. If you're the winner, you have to file a proper document by sending it to the owner informing them you own a tax lien on the property within a certain time frame. Miss that time frame and you jeopardize your ability to foreclose in the future.

Example 5 Illinois class of property for redemption. And speaking of foreclosure on tax lien certificates in Illinois, when you can foreclose (the "redemption" period the owner has to pay back the taxes) varies on the type of property. 6 months for vacant land. Is that all vacant land or only vacant residential versus vacant agricultural, versus vacant commercial? You need to read the statutes to understand all the rules in Illinois.

As you can see, tax lien investing is not as simple as the gurus make it out. Be prepared to dig in to the legalese of state, county, and sometimes, city statues related to tax lien sales. And don't forget, 95%-98% of all liens are paid back by the owners, so if you bid really low interest, or if you bid a high premium over the amount of taxes owed (didn't even touch that concept in this post) you are spending a lot of time for a little return.