What are the risks of tax lien investing? How can they be avoided or minimized?

“What are the major risks of tax lien investing?” is a common question I get. As a tax lien investment expert, I’ve learned where the risks are, what they are and what can be done about them.

The first risk is…

Risk 1: Not Understanding the Sale 

A lot of people get confused and think a tax lien sale and a tax deed sale are the same things. They are not. Here’s an explanation of the two. Knowing the difference is important.

In some sales, you can take possession of the property immediately. In some, you have to give the owner time to redeem the taxes by paying you for the taxes plus interest.

The tax collector in the community can tell you which kind of sale is held there. They can also explain the other details that follow a successful sale. These after-the-sale matters are critical. If you get something wrong after the sale, you could lose your entire investment.

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Risk 2: Not Doing Your Homework

You need to understand what you are buying, where you are buying, and what you can do with it. This means checking out the property as much as possible.

If you are new to tax lien or tax deed investing, start local. Call your tax collector and ask when the next sale will be. Then, ask what properties will be in that sale.

They may not be able to tell you exactly what properties will be planned for the sale until the advertising is underway. When the sale is announced, you can get a complete list of the properties from the tax office or the local newspaper.

When you get that list of properties, go and look at the properties that interest you. A good tool to become familiar with is Zillow.

Some questions to ask are:

  • What is the house like? Is it in good shape? Is there any obvious exterior damage? The condition of the yard can also give you a good idea of what the house’s inside is like. A well-kept yard means the inside is likely in good shape. A yard that’s a mess indicates the homeowner feels the same about the interior.
  • What is the neighborhood like? If you get the house, can you easily sell it or rent it?
  • If you are buying a house to live in, is that house you want to live in and a neighborhood you like?

Unfortunately, you’re probably not going to be able to actually go in the house for a physical inspection.

These risks in tax lien investing are the reason I recommend starting local. Once you get an idea of what to look for, you can expand your investment reach to other places.

When you go beyond your region, look at properties online. Street view mapping services can give you an excellent view of the exterior.

You can ask the tax office what condition the property is in. Sometimes they will tell you, sometimes not.

Risk 3: Bidding on Worthless Property 

Some properties go up for sale and are practically useless. I have seen auctions with parcels as small as one-tenth of an acre in what amounts to a swamp. There’s no house; it’s a vacant lot.

The owner has no intention of redeeming any taxes because the land can’t be used for anything. Buying the taxes on this kind of property is amistake.

risks of tax lien investing

If the sale shows the property has several years’ worth of unpaid taxes, that’s a good indicator that the property is not a good investment. If the property was a good investment, it would have sold at an earlier auction.

Risk 4: Not Understanding How Tax Lien Auctions Work

All these sales are done at auction. Some are in-person only. Some allow online bidding. You have to be at the auction to bid and to win. If you show up late or forget about it, all your pre-auction work is for naught.

Risk 5: Coming Down With Auction Fever

Tax liens are sold at an auction. If it’s a lively in-person auction, it is easy to get swept up in the excitement and overbid. If you overbid, you still have to pay for what you bought. If you don’t pay for the auction, you are subject to being banned from future auctions. You could also be forced to pay for your bid.

If you don’t get a property you had your eye on, you might be tempted to bid on another property in the sale. That’s OK if you have done your research on the other property.

Don’t buy just because you have the money available. Bankrate correctly points out that due diligence means checking out the available properties before the auction. Don’t get frustrated and rush to bid just because you can.

Risk 6: Poor Follow-Through

If you are buying in a state with a redemption period, you have to know how long that is. The tax office that held the sale can tell you this. Some states, like Georgia, have a foreclosure period before you can take the house.

Hiring an attorney to handle the foreclosure process is a good idea. The attorney can make sure everything is legal. Yes, this will cost a little bit, but if the owner redeems the property during the foreclosure period, these costs are added to what he has to pay you.

If the owner doesn’t redeem the property, you still own a house for a fraction of the real worth.

Risk 7: Other Taxes on the Property

Sometimes a property will be sold by one taxing agency and there are other outstanding taxes owed to another agency.

This is most common in states which have county taxes, city taxes, and school system taxes. The various tax sales don’t have to be held at the same time. Before you get to the auction, ask if there is another past-due tax from another board that needs to be settled. If so, you need to figure that into the total amount you will spend.

Be sure you pay off other taxes if there are any owed. If you don’t, someone could buy that other tax lien at the next auction and you lose the property.

If you buy in a state with a redemption period of a year or more, you will also have to pay the taxes that come due during the year. You will be reimbursed for these by the owner if he redeems the taxes.

Risk 8: The Homeowner Files For Bankruptcy

When a homeowner files for bankruptcy, this can put local property taxes on hold. If the owner files just before the sales are advertised or the auction starts, the tax agency may not find out in time to pull the property from the sale.

If you buy one of these properties under bankruptcy protection, you do get your money back, but you don’t make nearly as much profit as you otherwise could have.

How to Avoid the Biggest Risks of Tax Lien Investing

There’s certainly more you need to know about investing in tax liens. I am a Florida-based author and publisher who specializes in distressed properties. Visitors to my website tedthomas.com will find 3 must-see FREE instructional videos.

No credit card is required. The video lessons will give you everything you ever wanted to learn about government tax-defaulted real estate which is sold at public auctions for 10 cents to 20 cents on the dollar. You’ll also learn the secrets of tax lien certificates which pay guaranteed returns of 16%, 18%, up to 36%.

What other questions about tax lien investing do you have? Sign up for Ted’s FREE Wealth Without Risk Masterclass here.

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