Paying Off Back Taxes Can Be Good for Investors
The days of buying severely discounted brick-and-mortar real estate are gone. The number of foreclosure filings for the third quarter of 2015 were the lowest they've been since the same quarter of 2005, reports RealtyTrac. Interest rates remain near historically low levels, but housing inventory is way down in many markets around the country as bidding wars take home prices higher.
So what can real estate investors do to find a "good deal" on real estate these days? The answer may come from the taxman, in the form of tax liens and deeds.
"Purchasing a home just for what's owed in back taxes owed sounds like a great deal for investors. But the transactions are much more complicated, thanks to state laws and rules that must be followed," says Rick Sharga, executive vice president of Auction.com, an online real estate marketplace. "Whether they purchase at a live or online auction, investors wishing to pursue either tax liens or tax deeds must do their homework ahead of time to avoid getting burned later on."
Tax lien certificates or tax deeds. Property taxes are the lifeblood of any county, city or municipality. The money collected pay for all sorts of public services, from police and fire departments to street maintenance, libraries and other essential services.
Not surprisingly, there are laws, regulations and procedures to assure that the government collects those funds from somebody -- be it the delinquent taxpayer or someone else with a financial interest in the property.
If the taxpayer either does not or cannot pay the back taxes due, then the taxing entity can go after the funds owed in one of two ways, depending on state law.
In about half the states, the taxing entity can place a tax lien on the property and sell the right to collect on that lien (known as a tax lien certificate) to the winning bidder at auction.
In tax lien states, the successful bidder wins the right to take over the lien and to collect the back taxes, plus penalties and interest paid by the delinquent taxpayer who cannot sell or refinance the property until the lien (which is senior to even the mortgage on the property) is paid off.
In a few states like Florida, bidders at a tax lien auction bid interest rates on the certificate down, with the winner being the bidder who agrees to accept the lowest interest rate.
In the other states, the taxing entity sells the real estate outright at a tax deed auction, with an opening bid of the amount of back taxes owed plus fees. In tax deed states, the highest bidder will obtain a deed to the property.
"We're all bargain hunters, so we plan to buy property at close to back taxes, about 20 to 30 percent of retail value. It gives a competitive advantage to traditional real estate that's for sale," says longtime investor and author Ted Thomas.
Prior to the auctions, the local taxing entity (usually the county where the property is sited) will publish a list of the delinquent property owners and the auction dates in a newspaper and on the internet.
Tax auctions are most often held live at a designated location, but some counties offer online auctions, as well. The winning bidder must be able to pay the full amount immediately.
A safer, lower-risk investment. Thomas notes that one big advantage to buying tax liens or deeds compared to other types of real estate investing is dealing directly with the government without the need for middlemen, attorneys, Realtors or accountants, and with no commission to be paid out of the profit margin.
"Tax liens present an opportunity to create a nice investment portfolio with low risk and small investments," Thomas says. "These are safe investments secured by the real estate and protected by the local government tax code. And the certificates pay a high rate of interest."
In tax lien states, Thomas says it is rare that the property owner/taxpayer will not pay the back taxes owed eventually over time. The investor gets paid when the government gets paid -- including the amount of the initial investment plus interest -- and that can result in a good return on investment, depending on the state.
For example, Thomas notes that in Arizona, tax lien certificates pay 16 percent, while in Illinois they pay 36 percent, 24 percent in Iowa and in Georgia they pay 20 percent if the taxes are paid off during the first year, and then in subsequent years the interest goes up to as high as 50 percent depending on how long it takes the taxpayer to pay off the taxes owed.
Still, in the rare case that the taxpayer does not pay back the taxes owed, ownership of the property will transfer to the investor, who can then foreclose. In tax deed states like Texas, by contrast, the tax auction is in effect a foreclosure sale of the property.
However, Texas is one of a handful of tax deed states in the country that has a redemption period for taxpayers, depending on the circumstances. Arnie Abramson, a 22-year veteran investor, says there are a lot of rules to know when working this business in the Lone Star state.
With three exceptions, in most circumstances the redemption period for delinquent taxpayers is 180 days. However if the property either has an agricultural exemption, is selling only mineral rights or is a homestead, then the redemption period is two years.
"If they do redeem it, they must pay the investor back everything he paid plus some other things, including 25 percent interest if redeemed in the first year and 50 percent if redeemed during the second year. The thing that separates Texas is those numbers are not prorated," says Abramson, founder of the Texas Tax Sales Resource Group.
"Texas tax sales are not good if you're an investor who wants to flip the property. It's good if you're coming for cash flow," Abramson says.
It's not as easy as it seems. While the idea of buying a property for as little as the back taxes owed is attractive, if it was really that easy, everyone would be doing it.
Investing in tax liens and tax deeds takes a lot of due diligence, as there are pitfalls to be aware of before taking the plunge.
Thomas recommends that before an investor ever attends an auction with money in hand to buy, he or she should first attend an auction as an observer, or watch one online.
Then, before going at it for real, doing one's homework is essential to successful tax lien or tax deed investing. It is important, he notes, to know all the details about the property, such as its current condition, zoning restrictions, what easements exist, the amount of yearly property taxes, previous sales prices and what the amount of the most recent tax appraisal is. Searching the property details on Google or sites such as Zillow is a good place to start, since markets are constantly changing.
But first and foremost, it is key that the investor be familiar with the rules for that state and the county running the auction.
Tax liens and deeds are not only available on residential properties, but also on commercial properties, farms, ranches, vacant land and even boat slips.
"There's no recession in the tax deed or tax lien business," Thomas says.
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