Tax Liens: What You Need To Know Now

Key Takeaways

• Tax liens are legal claims placed on property by government entities for unpaid taxes
• They take priority over other claims against the property, including mortgages
• Tax lien certificates can be purchased by investors in many jurisdictions
• Interest rates on tax liens typically range from 8% to 36% depending on location
• Property owners have redemption periods to pay back taxes plus interest
• Tax liens can be removed by paying the tax debt or through bankruptcy in some cases
• Due diligence is essential before investing in tax lien certificates

Understanding Tax Liens and How They Work

A tax lien is a legal claim against a property that has delinquent taxes. When property owners fail to pay their property taxes, income taxes, or other tax obligations, government entities place these liens to secure payment of the debt. Tax liens take precedence over virtually all other claims against the property, including first mortgages.

There are several types of tax liens:

• Property tax liens - Placed by local governments for unpaid property taxes
• Federal tax liens - Placed by the IRS for unpaid federal taxes
• State tax liens - Placed by state tax authorities for unpaid state taxes

The tax lien process typically begins with multiple notices to the property owner about their delinquent status. If the taxes remain unpaid after these notices, the taxing authority files a lien against the property. This filing creates a public record of the debt and establishes the government's legal claim to the property.

Tax Lien Certificates as Investment Vehicles

Many jurisdictions sell tax lien certificates to investors through auctions. These certificates transfer the tax lien from the government to the investor, who then has the right to collect the delinquent taxes plus interest from the property owner.

The investment appeal of tax lien certificates comes from their interest rates, which can range from 8% to 36% depending on the jurisdiction. These rates are set by state law and vary widely across the country. For example:

The auction process typically works in one of two ways:

• Bid-down interest rate - Investors compete by bidding down the interest rate they're willing to accept
• Premium bid - Investors bid a premium above the lien amount, with the highest bidder winning

If the property owner fails to redeem the certificate by paying the taxes plus interest within the redemption period (typically 1-3 years), the investor may be able to foreclose on the property. However, most tax liens (95-97%) are redeemed before reaching foreclosure.

Implications for Property Owners

For property owners, tax liens create serious financial and legal complications. Once a tax lien is filed, it can:

• Damage your credit score
• Make it difficult to sell or refinance the property
• Eventually lead to loss of the property through foreclosure
• Accrue additional penalties and interest

When facing a tax lien, property owners have several options:

Pay the debt in full - This is the most straightforward solution. Once paid, you can request a lien release from the taxing authority.

Set up a payment plan - Many tax authorities will work with property owners to establish manageable payment plans.

Request an Offer in Compromise - In some cases, particularly with federal tax liens, you may be able to settle the debt for less than the full amount owed.

File for bankruptcy - Certain tax debts can be discharged through bankruptcy, though this varies by the type and age of the tax debt.

The redemption period gives property owners time to pay the delinquent taxes plus interest and penalties. This period varies by jurisdiction but typically ranges from 6 months to 3 years. During this time, the property owner maintains ownership rights but has the added burden of accumulating interest on the debt.

Due Diligence for Tax Lien Investors

Investing in tax liens requires thorough research and understanding of the local market and legal framework. Before purchasing tax lien certificates, investors should:

Research the property - Physical inspection is essential. A tax lien on an abandoned, damaged, or environmentally contaminated property may not be a sound investment, even if the interest rate is attractive.

Verify ownership and other liens - Title searches help identify who owns the property and whether other liens exist. Multiple liens can complicate the foreclosure process if the tax lien isn't redeemed.

Understand local laws - Redemption periods, interest rates, and foreclosure procedures vary significantly by jurisdiction. Local knowledge is valuable.

Calculate potential returns - Consider not just the interest rate but also:

• How long your capital might be tied up
• Administrative costs of managing the investment
• Potential legal fees if foreclosure becomes necessary
• Property taxes you might need to pay while holding the lien

Tax lien investing isn't passive income. It requires active management, record-keeping, and sometimes legal action. Many successful tax lien investors focus on specific counties or states where they develop expertise in local procedures and market conditions.

Frequently Asked Questions

How long does a tax lien stay on my property?

A tax lien generally remains on your property until the debt is paid in full, including all interest and penalties. After payment, you should receive a lien release document that you can file with your county recorder's office.

Can tax liens be sold to collection agencies?

Yes, in some jurisdictions, tax authorities can sell delinquent tax debts to private collection agencies. These agencies then have the right to collect the debt and may place their own liens on the property.

Will a tax lien affect my credit score?

Yes, tax liens can significantly impact your credit score. While credit bureaus have removed tax liens from credit reports in recent years, lenders can still discover them through public records searches during loan applications.

Can I buy a property with a tax lien?

Yes, but with caution. When you buy a property, you typically take it subject to any existing liens. This means you could become responsible for the tax debt. A thorough title search before purchase is essential.

How do I know if there's a tax lien on my property?

Tax liens are public records. You can check with your county recorder's office, county treasurer, or tax assessor. Many counties now have online databases where you can search for liens by property address or owner name.

Conclusion

Tax liens represent a critical intersection of government authority, property rights, and investment opportunity. For property owners, understanding how to prevent, manage, and remove tax liens helps protect valuable assets. For investors, tax lien certificates offer potentially attractive returns, though they require diligence and expertise.

The tax lien system serves an important public function by helping governments collect needed revenue while giving property owners time to resolve their tax debts. Whether you're a homeowner concerned about potential liens or an investor considering this market, knowledge of how the system works in your specific jurisdiction is invaluable.