Investors can use their IRA to engage in real estate investments through tax lien investing. This post talks about what a tax lien is and how to use an IRA to invest in one.
In this article:
- Tax Lien Definition
- How a Tax Lien Sale Works
- Benefits of Tax Lien Investing
- Disadvantages of a Tax Lien Investment
- Tax Lien Investing Inside a Self-Directed IRA LLC
Know How Tax Lien Investing Works and How to Make It a Profitable Investment
Tax Lien Definition
Tax lien investing is one of the lesser-known types of investment inside your IRA. It’s set to increase in trend and continues to gain popularity with investors of every level.
However, exploring how it all works teaches you not just the advantages of maximizing your return on investment (ROI) but also how to manage the complexities when you buy a tax lien through a tax lien auction.
Learn how to make tax lien investing a win-win situation for you as a tax lien investor by reading more below.
What is a Tax Lien?
The government can place a lien on the property when the owner becomes delinquent with paying property taxes. In some cases, it doesn’t happen immediately since some municipalities give them a couple more chances to settle it.
If it’s tax lien investing, the local tax office can offer the tax lien to an investor engaged in real estate investment with enough funds to pay for the unpaid property taxes.
Instead, the investor earns passive income or profit through the accrued interest of the debt. The property owner usually has a year or two to settle the debt.
Once the owner settles the taxes, the investor then receives all the funds he paid plus interest.
Some people call tax lien investing “tax certificate investing” since the investor will get hold of the tax lien certificates until the redemption period is over.
What is a Tax Certificate?
A tax lien certificate encompasses the legal setting of a claim by the local government tax lien network over an asset or property owned by a taxpayer or business that was delinquent in paying their property taxes. This is the last resort in the hopes of making the property owner pay the unpaid tax.
Ways for Property Owners to Get Rid of a Tax Lien
- In order to remove the lien, the taxpayer needs to pay the debt to a tax collector, and then wait for the bankruptcy court to dismiss it.
- Another option is to make an offer in agreement with the authorities for taxes through a county treasurer office or a county treasurer.
- In some cases, such as when tax liens are filed without the consent of the property holder or when a lien expires, the landowner may file a quiet action lawsuit to remove the lien.
How a Tax Lien Sale Works
What Happens to a Property When a Lien is Placed on It?
When the local government attaches a lien on a property or federal tax lien, the owner cannot sell or refinance the property. It is only good to sell after paying the taxes, which, in effect, removes the lien.
Some people do try to do it secretly, but a diligent investor will know the parcel or lot of land has property tax liens. It can bring the cost of the property down significantly, or the sale becomes a no-go.
Who Benefits From Liens?
However, anyone can purchase these liens, and this is what investors are currently looking into.
Through the government tax lien, local governments can benefit from sales made by investors by regaining the owed taxes. Also, these tax liens have attached interest rates and other penalties due.
How to Invest in a Tax Lien
These certificates go through an auction, and depending on the state, can occur online or offline. Here’s how an investor can take ownership of a lien depending on state rules:
- The investor who places the highest bid gets the issuance of the tax certificate. Take note that the purchase rates depend on the size of the property with the tax lien. In this scenario, the winning bidder sets up an agreement with the property owner regarding repayment terms and interest rate.
- The municipality can also award the tax certificate to the bidder who is willing to accept the lowest possible interest rates. In situations like these, the government will continue collecting payments on behalf of the investor.
Either way, if the bidder used funds from an IRA, the IRA becomes the lienholder.
Benefits of Tax Lien Investing
1. Low Capital Requirement
One of the benefits of tax lien investing is its requirement for low capital. It is actually one of the lowest among other types of real estate investing since an investor can spend just a couple hundred dollars to invest in one.
2. Standard Rate of Returns
Another advantage is the standard rate when it comes to returns. This means you have a fair and exact amount of how much you earn regardless of the current market rates.
3. Potential for Higher Profit
In some cases, the interest rates are higher than the market. That in itself gives you the opportunity to earn a handsome profit from the passive income.
Disadvantages of a Tax Lien Investment
1. Location Status
You may have a hard time selling property found in problematic areas. Do your due diligence and research in the surrounding area of the property where you purchased the lien from.
Take this into consideration, especially if the area was recently affected by or is prone to natural occurrences (e.g., flooding or hurricanes).
2. Property Maintenance
Another thing to consider is if it is well-kept. Assess if you’re willing to shoulder the repair expenses caused by unforeseen events, which can damage the property.
3. Legalities Involved
- You want to make sure the property is free of any court or legal issues present during the tax lien process. An example is the failure to properly notify the owner that the property is near foreclosure.
- Another thing to consider is when the homeowner files for bankruptcy, which may delay or stall your investment. This can decrease your lien interest rate and result in changes in the schedule of payments.
It can be complicated, so make sure no one has hold of the tax lien before you consider investing in it.
Tax Lien Investing Inside a Self-Directed IRA LLC
You can initiate tax lien investing inside a self-directed IRA limited liability company (LLC). A real estate investor can add in their self-directed IRA a tax lien deed purchased through a tax deed sale.
The tax lien certificate and the tax lien deed are the two kinds of tax lien sales. These two are suitable for any investor with checkbook control. This type of account gives investors direct access to their funds, which is crucial in time-sensitive auction sales.
1. Tax Lien Deed
The deed sale does not require giving ample time to the property owner to pay back the taxes owed. The investor is also bidding for ownership of the property during the auction.
The transfer of ownership to the new owner happens upon approval of the selling price.
2. Tax Lien Certificate
In this tax sale, the property owner gets another chance to get the property back. This can be in the form of getting investment money through a third party.
During the bidding process, the investor agrees to lend the money to the property owner over an agreement to pay back the borrowed money with interest by a particular date.
They refer to this as the redemption or redemption period. If the homeowner is still unable to redeem the unpaid property taxes, the investor has the right to foreclose the property.
There are legalities involved upon pre-foreclosure wherein an attorney usually takes over in handling these matters. This also comes with a corresponding attorney fee.
In order to mitigate the complexities when it comes to tax lien investing and make sure you are getting the most out of it, it’s always wise to do your research.
When it comes to learning how to buy tax liens property, start by having full knowledge of the property, the neighborhood, and the town where it is located as well as all legalities concerned.
By carefully assessing all tax lien investing opportunities lying around, it can turn out to be a great investment to add into your IRA.
What other tax lien investing recommendations do you have? Please share your thoughts in the comments section below.
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Editor’s Note: This post was originally published on March 14, 2018, and has been updated for quality and relevancy.