Tax Foreclosures

How to Invest in Tax Foreclosures

Investing in tax foreclosures is one of the time-honored ways that new real estate investors get great discounts on attractive assets. They are often represented as “win-win” investments because they do not require as much responsibility as a directly owned piece of real estate and still generate returns (in most cases) if the homeowner redeems the property and the investor simply collects fees and interest instead of foreclosing on and owning the home. Before you start to invest in tax foreclosures, it is important to understand how the process works and what differences you may encounter from state to state. 

Tax Foreclosure Basics

Tax lien foreclosures are properties that have been repossessed by government agencies due to outstanding tax debt owed by a homeowner. A tax lien is essentially a debt owed on unpaid property taxes, income tax debt or other local, state or federal taxes that go unpaid, but tax liens are most commonly associated with unpaid federal taxes and unpaid property taxes. 

When a homeowner fails to pay their federal taxes, the Internal Revenue Service will issue a Notice of Federal Tax Lien, which outlines the amount owed in taxes to the government, plus additional fees and associated costs. If the tax debtor does not pay off their debt owed within the time frame specified by law, the IRS will issue a Notice of Federal Tax Lien. This essentially means that the government has the legal right to impose a lien on a tax debtor’s property, giving them the legal basis for eventually repossessing the property and selling at tax lien auction if the tax debt goes unpaid. The proceeds of the auction are then used to cover the debt owed. 

When homeowners fail to pay property taxes or utility bills, local governments can issue liens against the property. Those liens are then auctioned off at tax sales or tax lien auctions. Investors bid down the interest on the liens, which can start as high as 18 percent, and the winner has the right to collect on the debt, with interest, or foreclose under certain guidelines. Some tax lien investors prefer to simply collect on the debts while others bid only on properties that appear likely to fall into foreclosure. Because tax liens are often far less expensive than the value of the house, investors willing to wait on their returns can snag big gains when the note falls due if the homeowner elects not to pay. 

Tax Deed Investing 

In some states, the government forecloses on the property prior to the tax sale, also called a tax auction. In these states, investors bid for tax deed certificates instead of tax liens. The redemption period may be shorter in these states, and the bidding is on the actual payment amount rather than the interest rate of the lien because the investor is acquiring an actual deed rather than just the right to collect on a debt that might result in the eventual acquisition of a property. 

Tips & Tricks for Successful Tax Foreclosure Investing 

Tax lien investing and tax deed investing are great ways to start out in real estate, but investors must be aware of some tricky elements to both strategies: 

1.  The rules vary from city to city and state to state 

Although federal tax foreclosures work essentially the same way everywhere, the same is not true for property tax foreclosures. Know your local rules and regulations, or you will end up bidding too much or setting yourself up for failure with a bid that is too low to win. 

2.  You do not get paid right away. 

Remember that word, “redeemed,” that you read earlier in this article? Well, the redemption period on a tax foreclosure might be as long as three years. In most cases, it is at least 18 months. As a result, tax foreclosure investments are not very liquid in many cases, so investors should plan to consider any money invested using this strategy “off the table” for a while. 

3.  You might not get the property. 

The great thing about tax foreclosure investing is that if the homeowner redeems their property, you still get paid fees and interest on the loan. However, if you bid the interest rate down too far, you might not end up with a good investment. Also, if you were hoping to acquire properties through this method, then a redemption is bad news as well. Make sure you have a good exit strategy for both redemption and foreclosure in order to make the best of this type of investing. 

4.  Other liens can interfere with property values. 

In most cases, tax liens are the most senior liens on a property. This means that your lien gets paid before other debts against the home. However, you must confirm that your acquisition of the tax lien or tax deed wipes out other debt on the property. If you assume that it does and you are wrong, you could owe a lot of other parties money! 

5.  Public policy could affect your timeline. 

If you acquire a tax foreclosure and are ready to foreclose but there is a national or local eviction moratorium, you may have to put your plans on hold. Make sure that you will be able to take control of the property when you are legally entitled to do so and, if you will not, make sure that the acquisition still makes sense. 

Tax Foreclosure Investing Offers Endless Potential 

Compared to the volatile stock market or a competitive real estate market, tax foreclosures look like an attractive alternative for real estate investors. However, you must make sure you have access to all of the information available on a property before getting ready to bid in a tax sale. RealtyTrac is here to help you buy investment properties whether this is your first deal or your 500th. Our vast database of national foreclosures, REOs, and bank-owned properties is perfect for helping you find the best real estate investment for you. Sign Up Now and take full advantage of RealtyTrac’s FREE Trial, which allows you to search our real estate inventory free for 7 days. The perfect investment property could be waiting for you right around the corner!