A tax lien is the government’s subtle way of announcing to buyers it has a legal claim on the property until the tax debt is paid. Savvy property investors can find excellent deals at auctions. However, buying a house with a tax lien can be risky if you don’t know what you’re doing. This article takes a deep dive into everything you should know about homes and tax liens.
Table of contents:
Homes with tax liens can be lucrative investment opportunities. Investors can buy tax liens from the county for properties with unpaid taxes. In some cases, those properties can be bought as investment properties. However, more often than not, investors “just” get the higher interest payments of the tax lien until homeowners pay their debt.
Before we explore tax liens, let’s get our bearings. The tax liens we’re most interested in result from property tax delinquency. And property tax delinquency is complex terrain. Without proper preparation, it’s easy to get lost.
If you’re ready to start investing in homes with tax liens but are looking for financing, you can compare the best rates offered by personal loans, mortgage refinancing, home equity loans, and shared equity agreements. (This is free and will not damage your credit score.)
Property taxes: the delinquency landscape
Property taxes are a primary funding source for city and county governments. This is true across the United States. Property owners who fail to pay their property taxes are said to be delinquent. The consequences of this vary from state to state. But a couple of things are true regardless of the property’s location. Getting it out of delinquency will cost owners more than just paying their taxes in the first place. And if owners remain delinquent long enough, they can lose their property.
How city and county governments respond to property tax delinquency varies. In some states, these governments respond with tax liens. In others, they use tax deeds. And some use both tax liens and tax deeds.
Our focus in this article is properties with tax liens. So we won’t go into great detail on tax deeds. We will tell you about them briefly, though. We’ll also mention redemption deeds, which seem to confuse some people.
Homeowners who fail to pay their property taxes will face consequences. In some states, this means the county or city owed the taxes will sell tax deeds to the owners’ properties. Sales are typically by auction. In most cases, the owners will then have a certain amount of time to redeem their properties. To do this, they must pay all outstanding taxes, penalties, fees, and other costs. When they do this, they may receive a redemption deed. (This last part is what confuses some people. More on that below.)
The time these owners have to redeem their properties varies from one place to another. It could be as little as a couple of days, but longer is typical. Redemption periods greater than a few months are unusual. During this period, interest and penalties might accrue. If so, they are payable to the purchaser of the tax deed.
Online discussion of tax deeds and redemption deeds can be confusing and contradictory. One site says that “Redemption deeds are tax deeds with a redemption period.” Another claims that redemption deeds are what some states use instead of tax deeds and tax liens. Most sites that contrast tax liens and tax deeds, however, do not mention redemption deeds. So what are they?
Redemption deeds are evidence that you paid your taxes. If you redeem your home or land from a tax sale, you will obtain a redemption deed.
Liens in general
Liens are notices filed with appropriate state or local government offices. They assert a creditor’s legal claim that the owner of some property owes the creditor money. A lien attaches to the real or personal property it names. In essence, it turns that property into collateral. In the case of real property, liens typically get filed with the county recorder’s office. In some places, this is called the county records office. Some liens get filed with state agencies. Liens are usually matters of public record.
Liens on real property
Liens on real property can be a powerful incentive to pay creditors. If someone wants to buy your home but needs financing, you’ll have to settle all liens first. When a title search finds a lien on the property, your buyer’s mortgage lender will halt the financing process. The process will stay halted until you’ve taken care of the lien.
If the incentive fails, a creditor may foreclose and force sale of the property. In the case of a tax lien, this can’t be done until the period for redemption specified in state law has passed.
Property lien priority
A piece of real property can have more than one lien attached to it. This can make lien priority important. The basic rule for most liens is that the first ones filed have priority over those filed later. But certain types of liens, by law, take priority over liens recorded before them.
A property tax lien takes priority over most liens filed before it. One noteworthy exception is federal tax liens. These compete on equal footing with local governments’ liens to collect property tax debt. If a federal tax lien was filed first, it gets priority. (This is a simplified picture. Reality can be more complex. Review this IRS document, for example.)
Federal tax liens are not used as often as they once were. In 2020, the IRS filed 291,081 tax liens, which is a significant drop from the 1,096,376 tax liens filed in 2010.
Tax liens for sale
In states using tax liens, the local governments filing them do not stop at issuing the liens. They then sell them to investors. Buying these liens is one way to invest in houses with tax liens. If your goal is to acquire property at a below-market rate, however, buying a tax lien may have limited value. Few tax liens end in foreclosure and property transfer.
How few? We’ve seen figures as low as 1%. Buying tax liens can be a profitable investment. But it’s unlikely to result in your getting to foreclose on many properties. As well, lien foreclosures in most states will only allow you to force a foreclosure sale. This sale could mean big profit, no doubt about that. But it won’t make you owner of the property — unless yours is the winning bid at auction. The only sort of foreclosure that would make you owner of a property is strict foreclosure. And that sort of foreclosure is only available in Connecticut and Vermont.
Why invest in property with a tax lien?
The average American homeowner pays well over $2,000 in property taxes every year. This expense can be a burden to families of modest means. So it’s no wonder that property tax delinquency is a regular occurrence. As you already know, in many states, city and county governments respond to this with tax liens.
Most homeowners whose properties have these liens do end up paying what they owe and keeping their homes. So, investors who buy these liens don’t usually end up foreclosing on the properties. But this doesn’t mean buying the liens is a bad investment. Far from it!
If you buy tax liens as an investment, the interest and other charges the owners pay will come to you. The interest rate on these liens varies. In some states, whatever buyer offers to accept the lowest rate gets the lien. Even in such states, though, the winning bid is seldom lower than 4%. And it’s often higher.
Buying property tax liens at auction
First, city and county governments place liens on tax-delinquent properties. Second, they sell the liens to investors. They usually do this with an auction. Below is everything you’ll need to know to pick up a tax lien (or liens) at one of these auctions.
That technical detail aside, let’s go to auction.
The day of the auction
What the local government sells at these auctions are called tax lien certificates. Each certificate is for an amount equaling the total owed. This includes the unpaid property taxes plus any penalties, fees, and other costs. Normally, the certificates are issued once a year, a few months before they are auctioned off.
You’ll usually sign up in advance to participate in one of these auctions. When you do, take some time to research the properties involved. Buying tax liens is usually a low-risk investment. Even so, the tax lien certificates on some properties won’t be worth buying.
Beware of worthless properties
As a tax-lien investor, you can make profit in two ways. The most common is to collect income as owners bring their properties out of delinquency. The other is to win the right to sell the property through foreclosure. As already noted, this rarely happens with tax-lien properties. But it does happen.
But what if the owner makes no attempt to redeem the property and the property has no market value? Worthless properties are rare, but they do exist. A three-mile-long strip of land one foot wide beside a closed road might be an example. Maybe a property matching that description doesn’t exist anywhere in the real world. But, rest assured, properties just that worthless do exist.
Don’t bid too much
So, it’s important to make sure you don’t bid on tax liens for worthless properties. It’s also important to make sure your maximum bid will let you earn a profit. Don’t do something daft like bid more than what the owner will have to pay to redeem the property. In other words, pay close attention to the certificate amount. And leave yourself a safety margin.
The minimum or starting bid in these auctions will be the certificate amount. Cities and counties are not going to take a loss on these liens. This means that each higher bid will reduce your potential profit from interest. Don’t accidentally reduce it to nothing!
This might all seem too obvious to mention. But people do weird things in competitive bidding situations. Consider the time when the writer sold some movie tickets on eBay. This was not a premium event with tickets in short supply. Tickets were plentiful from all sources. Still, the winning bidder paid several dollars more than the going rate at eBay-adjacent Fandango.
Take the interest rate into account
Remembers that you’ll often be specifying the interest rate you’re willing to accept as part of your bid. (In some states, this is the part of your bid that will determine if you win the lien or not.) This rate will affect how much you earn if the owner redeems the property. In addition to keeping the certificate amount in mind, take this rate into account. Make sure you calculate your expected earnings in terms of the lowest rate you might get. And make sure you’ll make a profit even if you end up with that lowest rate. If you then get a better rate, that will just mean more profit.
The allowable interest rate will vary depending on the state where you are bidding. For example, in Florida, the maximum allowable interest rate is 18%. You should expect that most auctions will not end at the highest allowable rate. Bidders who win are typically willing to accept a much lower rate than the maximum.
Next steps after your winning bid
So yours is the winning bid on a property’s tax lien. Congratulations!
Here is where things get interesting. The tax lien certificate you’ve just purchased covers a property’s delinquent taxes for one year. If the owner pays these off over the next several months, say, you’ll earn a nice return. The higher the interest rate you landed, the better the returns will be.
But what happens if, instead, the owner continues to have trouble paying? What if the property remains delinquent through the following year? If the redemption window is greater than a year, you won’t be able to foreclose before that can happen. And redemption windows greater than a year are not uncommon.
Another year, another tax lien
What happens if the property covered by your certificate remains delinquent for another year? You can expect the city or county to file another tax lien and issue another certificate. It will then auction this off just like before. The laws in some states and localities are such that the new tax lien will take precedence over older ones. Unless you bid for and win the newly issued certificate, your ability to foreclose could be compromised.
Since your lien’s redemption period ends before the redemption period for the next lien in line, how can this be? Well, the owners of the lien following yours could pay yours off. This would give the newer lien owners first crack at foreclosure.
Of course, this means you’ll still get the interest income you were planning on. But when it becomes apparent the property owner is never going to pay, you may decide you really want to foreclose on the property. After all, who wouldn’t trade the cost of a few years’ property taxes for the proceeds of a foreclosure sale? We’re talking big profits here.
Keep buying liens…or make an offer?
Well, if you really want to foreclose on the property, you’d best buy every tax lien certificate the city or county sells until you can foreclose.
If waiting to foreclose gets tiresome, you could even see if the property owner is willing to sell at a low price. How low? Low enough for you to settle all the liens the owner can’t settle — yet still turn a profit when you resell the property. Before you try anything like this, though, make sure you’ve got your figures straight. If you don’t, your intended profit could end up a big loss.
Key takeaways and a few cautions
- Only some states use tax liens for unpaid property taxes. Other states issue tax deeds instead of tax liens. Still other states issue both, or issue one or the other in different situations.
- When owners fail to pay their property taxes, city and county governments (in applicable states) put tax liens on the properties.
- The governments sell these liens to investors as tax lien certificates.
- Buying a tax lien certificate, in effect, makes you the tax collector for those taxes. Interest applies to the unpaid taxes. If the owner redeems the property by paying the delinquent taxes, the money paid comes to you. The amount over what you paid for the certificate is your profit.
- Starting bids on tax lien certificates are what’s owed before adding interest that will accrue. So keep your bid below the expected return from interest added to what’s owed.
- There will be some period of time after tax liens are issued during which owners can redeem their properties. This period varies from state to state. It can range from a few months to several years.
- A property owner may fail to redeem the property within the redemption period. If so, the owner of the tax lien certificate may foreclose, forcing sale of the property.
- If the redemption period lasts more than a year, more than one tax lien could be attached to the same property.
- Purchases of tax lien certificates are “blind.” This means that you won’t be shown or allowed to inspect the property before buying its lien. Be aware of the risk and learn what you can about the property before bidding. You could even drive by the property. But be sure you don’t enter any property without the owner’s permission.
- When you make a purchase at a tax lien auction, you are unlikely to end up foreclosing on the property. Most owners redeem their properties. So most purchasers of tax liens just collect interest. Still, having to foreclose is a risk. If you just want the income and don’t want to risk having to foreclose, this may not be the investment for you.
- This is a shorter-term income investment. When you purchase tax liens and start receiving interest income, don’t treat the income like it will last forever. Make sure you know when redemption periods end. And make sure you know when owners will likely finish paying off what they owe.
- Investing in property tax liens can be complex. Beginners who aren’t careful can get into trouble. Makes sure you have a good understanding of the process and of the laws and procedures in your area. Start out small. If you find this is the right investment vehicle for you, you can start investing more money.
Buying houses with another type of lien
As you already know, property tax liens are not the only liens that can be attached to real property. Failure to pay federal income tax can also result in liens on properties. (Technically, federal tax liens are general liens. This means they attach to people, then through them to all their property. So far as any specific piece of real estate is concerned, though, the effect is the same. The property still has a lien on it.) Other failures to pay, like failures to pay remodeling contractors, can also cause liens on properties. This prompts many people to ask a number of questions. Let’s take some time to answer them.
Can a tax lien prevent you from buying a house?
Yes. Any lien on a property will show up in a title search. Do you need to finance your home purchase? If so, your mortgage lender will require that these liens be resolved before it makes the loan. Resolving these is the seller’s responsibility. If you have the funds to help out, however, offering to do so may give you leverage for a better deal on the purchase.
This means that any property with a lien on it might present an opportunity to buy at a discount. Are you a skilled deal maker?
Can you buy a house by paying the back taxes?
Back taxes can be the cause of a lien on real property. You can offer to pay the back taxes that are causing such a lien in exchange for a lower purchase price. Owners in tax distress can be motivated sellers. So identifying and contacting homeowners with federal tax liens can be a profitable use of your time. And it could lead to a profitable investment. Homeowners with property tax liens might also be willing to make deals. This could be another way to profit from property tax liens — even if you don’t purchase them.
What happens if you buy a property with a lien?
A mortgage lender won’t let your loan go through if the title report shows unresolved liens or judgments on the property. But what if you buy a house for cash and don’t have the right sort of professionals dot your i’s and cross your t’s? In that case, you might end up buying a property with a lien you don’t know about. Liens are attached to properties, not their owners. They’re what’s called appurtenant to the property.
So, if you buy a property with a lien, you could lose your property in foreclosure for the prior owner’s unpaid debt. You don’t become responsible for the prior owner’s debt, not legally. But your property remains subject to foreclosure should that debt remain unpaid. If you want to hold onto the property, you have to do one of the following:
- Convince the prior owner to pay off the debt and clear the lien. Good luck with that.
- Or pay the debt to resolve the lien and clear your title. That’s right, pay the debt you don’t owe and are not legally responsible for. You’ve made a costly mistake. Pay what you don’t owe or lose your property.
Does a tax lien supersede a mortgage?
If you’re asking about federal tax liens, the answer is “no.” If you’re asking about local property tax liens, the answer is “yes.” Bear in mind that “supersede” in this context means “take priority over.” It doesn’t mean “eliminate.” Also bear in mind that, in matters of law, simple “yes” and “no” answers seldom cover every situation.
In general, liens against real property can make property owners more ready to make deals. If you’re a talented deal maker and are good with numbers, any property with a lien on it could be your next money maker. When financing that next deal, make sure you compare multiple lenders before making a decision.
Even if you’re not a deal maker, you can still make money on houses with the right liens. Houses with property tax liens can be investment opportunities. Buying the liens themselves can provide a good rate of return with relatively low risk. There’s also a chance you’ll acquire the underlying property through foreclosure.
Not sure if tax-lien properties are the right investment for you? Then read our guide to investing to learn about some other possibilities.
- How to sell a house with a tax lien — SuperMoney
- Common questions about tax liens — National Tax Lien Association
- Lien — Merriam-Webster
- Priority of Federal Tax Lien: “First in time, first in right” — IRS
- Real Estate Broker Prelicensing series — Travis Everette (North Carolina)
- Redemption Deed Law and Legal Definition — USLegal
- What if there is a federal tax lien on my home? — IRS
- What Is a Property Lien? An Unpaid Debt That Could Trip Up Your Home Sale — Realtor.com
- What Is Strict Foreclosure? — Nolo