When buying tax liens, it’s important to understand the risks of tax lien investing. Here are some tax lien pitfalls a tax buyer needs to know.
Q: I’m interested in getting involved in property tax lien purchases in Queens, New York. It seems everyone I ask shies away from answering my questions. I’m hoping you can help.
If we bid at the tax auction, we get 18 percent from the owner and the owner has one year to redeem his taxes. What fees can I charge the delinquent property owner upon redemption besides the 18 percent interest compounded daily? If they do not redeem, does the government then issue a deed automatically in my name?
A: When bank accounts are paying nearly nothing for deposits and money market funds pay just a bit more than nothing, 18 percent sounds pretty good to us. We can’t give you specific information for Queens, New York, but the process is somewhat similar in quite a number of jurisdictions across the country. Here’s how it works.
If you are a property owner and receive a tax bill, you must pay that tax bill within a certain number of days. If you don’t pay your taxes, your local government starts to add interest onto your real estate tax bill. In some states, that interest rate can be around 18 percent. While we haven’t checked what other states charge, some may be higher and others lower.
If you still haven’t paid your real estate taxes within a year or two, the local municipality has the right to sell the taxes. By selling the taxes, the local municipality gets its money from the tax buyer and the local municipality can continue to fund its government obligations. Now the tax buyer gets the right to collect interest on that money. If you were the tax buyer, you’d get the right to collect interest at the rate of 18 percent.
Most homeowners find out eventually that they have failed to pay their real estate taxes. At that point, they run down to the tax collector’s office with cash in hand to pay the debt due. When they get to the tax collector’s office, the homeowner receives a bill for the taxes owed, interest that’s accrued, along with other costs and expenses. These costs and expenses are usually set by statute but can be expensive. When the homeowner makes that payment, some of the funds go to the municipality to cover expenses and the tax buyer gets back the money they paid for the taxes along with the interest owed.
For the tax buyer it’s a good investment. They put up the money and can earn a rather nice rate of interest on that money until the homeowner comes up with the money to pay the tax bill owed. Once the cash is paid, the back taxes are considered “redeemed” and the property tax account is settled.
Some homeowners can’t, or won’t, pay their real estate tax bills. It’s in these cases that the tax buyers can end up as owners of these properties. The sequence of events is as follows: the property owner fails to pay his or her real estate taxes; the local taxing body “sells” the taxes to a tax buyer at a tax auction; a tax buyer pays the municipality the amount of unpaid real estate taxes; the tax buyer receives a document evidencing the tax payment; the property owner gets a fixed amount of time to pay what is owed, redeem the taxes or lose his or her property; the homeowner never shows up to pay the bill; and, finally, the tax buyer receives a tax deed transferring title of the property to the tax buyer.
Once that tax deed is issued, the tax buyer, under most circumstances, becomes the owner of the property. It’s a fair deal, you might think. The tax buyer put up the amount that was unpaid in real estate property taxes and ended up owning the property.
If only it were that easy. You need to know that there are quite a number of pitfalls along the way. If you don’t know the properties involved, you may end up paying real estate taxes on properties that have no value and no use. You can also invest in properties where the municipality has made a mistake and in correcting the mistake, you end up investing in those taxes but getting your money back without interest.
One last item you should consider is that in some states those tax “auctions” are exactly that. They are tax auctions. The highest bidder ends up as the tax buyer. If the property owner owes $10,000 in real estate taxes, you might bid the $10,000 and become the tax buyer, but in many cases there will be multiple tax buyers bidding on the same tax amounts. Those tax buyers may end up bidding more than $10,000 to become the tax buyer on those taxes. The return on the investment for these tax buyers will be less than the 18 percent interests offered with a risk that you might not get all your money back should the property owner redeem immediately or the sale is reversed.
If you want to get into this business, and it is a business, you’d better know the process well and understand the risks involved. Otherwise, tax buying may not be for you.