Tax Liens: What to Know

What Is a Tax Lien?

A tax lien represents a government's legal claim against your assets when you neglect or fail to pay a tax debt on time. The lien protects the government's interest in all your property, including real estate, personal property, and financial assets.

There are several types of tax liens:

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

When a tax lien is filed, it becomes public record and appears on your credit report, potentially damaging your credit score. This can make it difficult to sell or refinance property, obtain new lines of credit, or secure loans. The lien remains until the tax debt is paid in full or until the statute of limitations on the debt expires.

How Tax Liens Affect Property Owners

If you're a property owner facing a tax lien, you should understand the serious implications this can have on your financial situation.

A tax lien can impact you in several ways:

• Creates a cloud on your property title, making it difficult to sell or transfer ownership
• Appears on credit reports for up to seven years, even after paying the debt
• Gives the government priority over other creditors if you file for bankruptcy
• May lead to tax levy (actual seizure of assets) if left unresolved

If you find yourself with a tax lien, you have several options to address it:

Acting promptly when facing a tax lien is always recommended. The longer you wait, the more interest and penalties accumulate, making the total debt larger and more difficult to resolve.

Tax Lien Certificates as Investments

For investors, tax lien certificates present an alternative investment opportunity with potentially attractive returns. When property owners fail to pay their property taxes, many local governments sell tax lien certificates to recoup the owed taxes.

Here's how tax lien investing works:

• Local governments auction tax lien certificates to investors
• The investor pays the outstanding tax amount to the government
• The investor now holds the lien against the property
• Property owners must pay the investor the original tax amount plus interest
• If the property owner doesn't pay, the investor may foreclose on the property

The appeal of tax lien certificates lies in their interest rates, which vary by jurisdiction but typically range from 8% to 36% annually. These rates are set by state law and not by market conditions, making them relatively stable investments.

However, tax lien investing isn't without risks. Some property owners never pay their debt, forcing investors to either foreclose or lose their investment. Additionally, properties may have environmental issues or other liabilities that make them less valuable than the investment. Research and due diligence are absolutely necessary before purchasing any tax lien certificate.

The Tax Lien Process Timeline

Understanding the timeline of the tax lien process helps both property owners and investors navigate this complex legal procedure.

For property owners, the process typically follows these steps:

1. Tax becomes delinquent after missing payment deadlines
2. The taxing authority sends notices of the delinquency
3. A tax lien is placed on the property
4. The lien is recorded with the county recorder's office
5. The tax authority may sell the lien as a certificate to investors
6. The property owner has a redemption period to pay the debt plus interest
7. If unpaid, the lienholder may initiate foreclosure proceedings

For investors, the process involves:

1. Researching available tax lien auctions in target jurisdictions
2. Performing due diligence on properties with delinquent taxes
3. Attending the auction and bidding on desired certificates
4. Paying for any won certificates
5. Receiving the tax lien certificate from the government
6. Waiting through the redemption period
7. Either collecting payment plus interest or starting foreclosure

The redemption period—the time property owners have to pay their debt—varies significantly by state, ranging from six months to three years. During this period, interest accrues on the original tax amount, which becomes payable to the certificate holder.

Avoiding and Removing Tax Liens

Prevention is always better than cure when it comes to tax liens. If you're a property owner, you can take several steps to avoid having a tax lien placed on your assets.

Preventive measures include:

• Filing all required tax returns on time
• Paying taxes when due or requesting an extension if needed
• Setting up automatic payments for property taxes
• Creating a dedicated savings account for tax obligations
• Working with a tax professional to plan for tax liabilities

If you already have a tax lien, there are several ways to address it:

The Fresh Start Program: The IRS offers this program to help taxpayers with tax liens. Under certain conditions, the IRS may:

• Withdraw a lien notice after taxes are paid
• Withdraw a lien if you enter into a Direct Debit Installment Agreement
• Not file a tax lien notice for certain taxpayers with small tax debts

Subordination: This doesn't remove the lien but allows other creditors to move ahead of the IRS in priority. This might help you get a loan or mortgage despite the lien.

Discharge: Under specific circumstances, you can request that a tax lien be removed from a particular property.

Working with a tax attorney or qualified tax professional can help you navigate these options and find the best solution for your specific situation.