Buying a Property with Delinquent Taxes
When looking to diversify their portfolios, many investors choose to invest in tax-delinquent properties. After considering the current real estate market and interest rates, many look toward tax liens for the source of their next investment. While risky, buying tax liens and property with delinquent taxes is potentially profitable if done wisely.
What Are Delinquent Taxes?
Delinquent taxes are unpaid taxes owed to the IRS. Investopedia explains that with tax delinquency comes additional penalties and interest added to the debt. Filing or payment must be made within eight weeks of receiving a delinquent-tax notice. If you are unable to repay the balance in full, you can opt for an installment or partial payment plan. In extreme cases, the IRS can deem one “not currently collectible” and temporarily delay collection.
If the delinquent taxes are left unpaid, the IRS will issue a bill for the amount that is past due, including penalties and interest that has accrued since the original bill was issued. (The interest continues to compound daily.) The IRS will then pursue aggressive collection methods to ensure that the debt is paid. They can garnish wages or even place a tax lien on property and assets. It’s ideal to avoid this sort of situation whenever possible, as going down the road of wage garnishment can be extremely challenging to reverse if your finances don’t permit repayment of the taxes owed.
What Is a Tax Lien?
A tax lien is one method the government, whether it’s the IRS or the county, uses to recoup unpaid taxes. Investopedia says that a tax lien is a legal claim to a piece of property made when the owner fails to pay what is owed in property taxes. When a lien is placed on a property, creditors are notified, and the city or county in which the property is located issues a tax-lien certificate. The certificate covers the amount owed on the property and any additional interest or penalties. Tax liens can be issued by the county or state or federally by the IRS.
The IRS notes that a tax lien is not just limited to property and can apply to all assets and future assets acquired during the lien. They can also attach to business property, all rights to business property and accounts receivable. Once a lien is placed, the IRS notifies creditors by filing a notice of federal tax lien, which can negatively affect future credit attempts. Tax liens and notices can also persist after bankruptcy.
Owners with a tax lien on their property are left with a few options. The IRS explains that the best way to discharge a lien is to repay the delinquent taxes in full. Liens could also be discharged without the payment of delinquent taxes, but the property and situation must meet the Internal Revenue Code. Liens may also be eligible for subordination, in which the IRS lien is moved below other creditors in priority, or withdrawal, in which the IRS removes the public notice on the lien. The delinquent taxes still need to be repaid in full in both situations.
Types of Tax Liens
There are three types of tax liens: federal, state income and property. Issued by the IRS, PropLogix explains that these liens can remain on the property after foreclosure and still have to be repaid by the buyer as long as the IRS redeems the lien within 120 days of the recording of the new deed.
State income liens are filed when individual income taxes are left unpaid; the duration of these liens varies by state. PropLogix notes that, for example, state child support liens remain on the property until the payment is fulfilled. Property tax liens are issued by the county when property taxes go unpaid. If the delinquent taxes are not repaid within the set time frame, the property will be put up for auction in a tax-deed sale.
The sale does not transfer ownership of the property. If the original owner repays the delinquent taxes within a set time frame, the lien is removed, and the certificate holder is reimbursed in full plus interest. If the delinquent taxes are left unpaid, then the certificate holder can initiate a public auction that will discharge the lien and pay off the property tax debt that has accrued since the lien was issued.
Buying Tax Liens
Tax liens are auctioned off just like property, either online or in person, Investopedia explains. Investors looking to purchase tax-delinquent property can choose from residential, commercial or undeveloped land from a tax-lien properties list. Their level of return on the tax lien will depend on several variables, such as the price for which they purchased the lien, the location and type of property and other unforeseen circumstances.
Investors should research the property before the auction. Often, the market value of the property is less than the cost of the lien. Other liens could also exist on the property, which would prevent the investor from assuming ownership later. Potential investors can contact the county treasurer’s office for a tax-lien property list detailing scheduled auctions and whether they will be held in person or online. For information on a specific property, the office should supply more information on when that lien will appear on the schedule.
Once the lien is purchased, investors pay the delinquent taxes, interest and any additional accrued charges. Once the investor assumes ownership of the tax lien, the property owner must repay the debt to the investor, including interest, which typically ranges around 10 to 12 percent, according to Investopedia. If the investor bought the lien at a premium, the property owner must pay that as well. If the property owner cannot meet the payments, the investor can then foreclose on the property.
Buying Tax Deeds
Some tax-delinquent properties are sold through tax-deed property sales. Unlike tax-lien sales, buyers from a tax-deed sale receive ownership of the property upon purchase. Tax-deed sales operate the same as a foreclosure: The sale proceeds will pay off the lien. Tax-deed sales must be publicly advertised, and buyers must pay in cash within 24 hours of the winning bid. The property’s entry is forbidden, which is why these properties are often sold for significantly less than their neighbors since only the exterior can be viewed before purchase.
Since potential investors must purchase sight unseen, it is recommended that you assume that the property is in poor condition and will require remodeling. Keep this in mind when determining the property value. Potential investors should also check if any additional liens exist on the property, such as municipal fines and code violations. With all of this in mind, investors should determine their maximum bid.
Specific laws on tax liens and tax-deed sales vary by state; for instance, some states don’t allow auctions, while others don’t allow tax-deed sales. Before investing in tax-delinquent property, always perform ample research on the state’s laws and restrictions.
Pros and Cons of Buying a Property with Delinquent Taxes
There are many positive aspects to buying a property with delinquent taxes. One positive aspect is that every real estate investor is looking for motivated sellers. Many chase foreclosures, probate homes, those late on their mortgages or with rundown homes with lots of deferred maintenance to find those motivated sellers. Some of these things may overlap with past-due property taxes, but not always. Everything else may be great. Seeking tax-delinquent properties could be a good method of connecting with owners who are serious about selling houses fast.
Whether you are buying a new residence, a second or vacation home or an investment property, having some leverage in negotiations is always a perk. Buying tax-delinquent properties isn’t just about looking for low prices, either. The experienced know that being able to negotiate more of the terms you want can be even more important. That includes closing dates, financing, inspections and repairs.
However, there are also negative aspects of buying a tax-delinquent property. One problem with properties with large past-due tax bills is that these liens can quickly eat up a lot of equity. We’ve begun to see more American properties slide back into negative equity or underwater positions. Just one year of delinquent annual property taxes can add over $10,000 to that problem. Some owe hundreds of thousands in back taxes. In some cases, you might find a “cheap” house deal that has more in delinquent taxes than the price of the house, or even the value of the house.
Often, past-due property taxes is just the tip of the iceberg of the problems — not always, but it’s quite likely. There may be many other past-due bills like utilities, mortgage payments, insurance and more. Or, the owners may have given up on the property due to other legal issues, code violations or rehab project roadblocks. Many of these can be overcome, but you’ve got to know what you are really dealing with before you get in and can assess it as a viable deal and at what price.
Initially, buying a property with delinquent taxes may seem almost too good to be true. However, this form of investing requires a lot of capital upfront and comes with a multitude of risks.
Be sure to conduct research beforehand. It’s imperative that you make sure the property is in good condition before deciding to invest. In the long run, investing in tax liens give you the opportunity to diversify your portfolio like other investments can’t.
Adam Smith has spent the last 5 years in the Private Money Lending world helping real estate investors secure financing for their non-owner occupied real estate investments. When he’s not thinking about real estate, Adam is an avid Jazz music fan and fisherman.