Tax Lien Investing: A Starter Guide
Tax lien investing is a strategy where you purchase the right to collect delinquent property taxes from a property owner. In exchange, you earn interest on the outstanding balance. If the owner does not repay the taxes plus interest within the redemption period, you may have the right to foreclose on the property and take ownership. It is one of the few investment strategies backed by real estate where you can earn fixed returns without managing tenants or property.
How tax lien auctions work
When property owners fail to pay their property taxes, the county government needs to collect the revenue. In tax lien states, the county sells the delinquent tax balance as a certificate to investors at a public auction. The investor pays the back taxes on behalf of the owner and receives a certificate entitling them to repayment plus interest.
Auction formats vary by county:
- Bid down the interest rate: The county sets a maximum interest rate (often 12-36% depending on the state) and investors bid the rate down. The investor willing to accept the lowest rate wins the certificate. This is common in Florida, Arizona, and New Jersey.
- Premium bidding: Investors bid amounts above the tax lien value. The highest bidder wins but the premium paid is not recoverable. Interest is only earned on the original lien amount.
- Rotational or random assignment: Some counties assign liens to registered investors on a rotating basis rather than through competitive bidding.
Interest rates by state
Tax lien interest rates vary significantly:
- Arizona: Up to 16% per year
- Florida: Up to 18% per year (bid down)
- New Jersey: Up to 18% per year (bid down)
- Illinois: Up to 36% penalty (every 6 months)
- Indiana: 10-25% depending on delinquency duration
- Iowa: 24% per year
These rates are statutory maximums. Competitive auctions often drive actual yields well below the maximum, especially in desirable markets with many investors bidding.
The redemption period
After you purchase a tax lien, the property owner has a redemption period to pay you back. During this time, the owner must repay the full lien amount plus accrued interest. Redemption periods range from 6 months to 3 years depending on the state.
The vast majority of tax liens are redeemed. Estimates range from 90-97% redemption rates nationally. This means you get your principal back plus interest on most investments. The small percentage that are not redeemed give you the right to foreclose on the property, which is where the larger returns (or losses) occur.
When liens are not redeemed
If the owner does not redeem during the specified period, you can initiate foreclosure proceedings (the process varies by state). If successful, you acquire the property for approximately the cost of the tax lien plus legal fees. This sounds like a windfall, and it can be, but it carries risks:
- The property may be worthless: Vacant lots, contaminated land, or properties in severe disrepair may not be worth the cost of foreclosure.
- Senior liens may exist: IRS liens and certain other claims may survive the tax lien foreclosure, meaning you inherit those obligations.
- Legal costs: The foreclosure process itself costs $1,000-$5,000 in attorney fees and court costs.
- Property condition unknown: You typically cannot inspect the property before the auction, so you are buying blind.
Due diligence before buying
Before bidding on any tax lien, research:
- Property value: Use property data tools to estimate the property value. Your lien investment should be a small fraction of the property value for safety.
- Property type: Single-family homes in good neighborhoods are the safest collateral. Vacant land and commercial properties carry more risk.
- Other liens: Check for existing mortgages, HOA liens, and other encumbrances. A property with a large mortgage is more likely to be redeemed (the mortgage holder will pay the taxes to protect their lien position).
- Environmental issues: Avoid properties with known environmental contamination. Acquiring a contaminated property through tax lien foreclosure can make you responsible for remediation costs.
Tax lien investing vs wholesaling
Tax lien investing and wholesaling are complementary strategies. Tax liens provide passive fixed-income returns, while wholesaling provides active transactional income. Many investors use tax lien returns to fund their wholesaling marketing budget or vice versa.
Additionally, properties approaching tax sale are excellent wholesale leads. The owner is under pressure to sell before losing the property at auction. By monitoring tax delinquency lists, you can identify wholesale leads and tax lien investment opportunities from the same data source.
Getting started
- Research tax lien laws in your target state
- Register with your county tax collector's office for upcoming auctions
- Review the auction list and perform due diligence on properties
- Set a maximum bid (interest rate floor) for each lien
- Attend the auction (many are now online) and bid within your parameters
- Track your liens and monitor for redemption
- If not redeemed, evaluate whether foreclosure is worthwhile
Related articles
- Tax Deed Investing: How It Works
- Wholesaling Tax Lien Properties
- Buying at Real Estate Auctions
- Note Buying Basics for RE Investors