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What You Need To Know Before Attending a Tax Lien Auction

Interested in tax lien investing? Here's what you need to know before you attend a tax lien auction.

[Updated: Feb 04, 2021 ] Mar 23, 2020 by Liz Brumer
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Interested in buying tax liens from a tax lien auction? These passive investments can be a profitable venture for real estate investors seeking a relatively low-risk investment secured by real estate, but attending a tax lien auction and winning a worthwhile tax lien isn't always easy. Here is what you need to know before attending a tax lien auction.

How a tax lien auction works

If a property owner fails to pay their real estate taxes, the local municipality will place a tax lien on the property, which secures the municipality's right to reclaim the unpaid taxes.

In order for the taxing authority to recoup the delinquent taxes as quickly as possible, they sell the tax liens at a public tax lien certificate sale rather than waiting for the property owner to pay or possibly not pay the delinquent taxes at all. Registered third-party investors attend the public auction, which can be held in person or online, and bid on the tax lien. The highest bidder wins the tax lien and now has the right to collect the unpaid property taxes plus interest, fees, and penalties.

The property owner is expected to repay the unpaid taxes within a specific period of time, called the redemption period, which varies from state to state and among municipalities. In some states, if the property tax lien goes unpaid beyond the redemption period, the tax lien holder can apply for a tax deed and has the opportunity to recoup the investment at a public tax deed sale or by gaining title to the real property.

The tax lien sale process and allowable interest rates successful bidders can receive vary dramatically from state to state. For example, Arizona uses the bid-down method, meaning bidders bid down the rate of return they receive starting at the maximum allowable return, which is 16%. Florida, who also uses the bid-down method, has a maximum allowable interest rate of 18%. Kentucky offers an annual rate of return of 12%, or 1% per month. For this reason, it's extremely important that you get familiar with the auction process and laws in your target market before attending or participating in a tax lien auction.

Benefits of investing in tax liens

The main benefit of purchasing a tax lien certificate is that they can be purchased for a relatively low cost and, once acquired, are a passive, hands-off investment. This makes tax lien certificates a great option for growing a self-directed individual retirement account (SDIRA) or solo 401k plan or for investors who are seeking passive investments with relatively consistent returns.

Pros and cons of purchasing at a tax lien auction

Purchasing a tax lien at a tax lien auction can be challenging. Some counties and states are very competitive, where the bidders bid the tax lien certificates as low as 0% to 2%, regardless of what the maximum interest rate on the tax lien is for the municipality.

Tax lien auctions also require a fair amount of upfront due diligence, including verifying property value, condition, and other liens or assessments that could cloud the title. This can be a lot of work and time for an asset that you may not win.

Additionally, there is always the risk the property owner does not pay the unpaid taxes within the redemption period. If it is a state that does conduct a tax deed sale and the tax lien certificate expires, the right to collect the unpaid taxes must be recouped through a formal foreclosure process, which can be lengthy or complicated, especially if there other liens encumbering the property.

Top tips for investing in tax liens

1. Tax lien investing takes patience.

Most investors conduct due diligence and bid on dozens of certificates before winning a tax lien certificate at their desired rate of return. Be patient, and don't compromise your rate of return because other investors are overbidding.

2. Conduct thorough due diligence.

Know what you're buying. Even if the goal of buying a tax lien certificate is to never gain title to the property, there is always that chance. Verify the value of the property, search for other liens or title defects, and ensure you are buying a worthwhile investment.

3. Know the process for your local municipality.

While most states have a defined maximum interest, the auction process can vary. Some counties offer online bidding to registered bidders while others do not require the bidder to preregister and instead only allow people who attend the live auction to bid. Each county will also have different timelines for when the winning bid amount should be paid and options for payment, such as a cashier's check or wire transfer.

If you're interested in tax lien investing, continue educating yourself on the process at a local level and speak with someone at the taxing authority or experienced in tax lien investing to help you understand the process further.

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