1) Tax Lien Basics

Hi.  Let’s talk about the tax lien system.

PROPERTY TAXES

Every property owner in the United States is required to pay property taxes. These property taxes go to the county or municipal government and are the primary source of income for most local governments. The government then uses this money to pay for crucial programs like public education including schools, teacher salaries, janitors, and bus drivers, it pays for police departments, fire departments, roads, signs, and parks. Property taxes are extremely important.

The amount that a property owner pays in taxes varies by property type and the assessed property value. States typically charge a property tax rate of 1 – 2 percent, but they can be much higher or lower depending largely on the demands of government programs in the state.

Here are some of the most expensive states:

• New Jersey (2.47%)
• Illinois (2.3%)
• New Hampshire (2.2%)
• Connecticut (2.11%)
• Wisconsin (1.91%)

And here are some states with the lowest property tax rates:

• Washington DC (0.55%)
• Louisiana (0.53%)
• Colorado (0.53%)
• Alabama (0.42%)
• Hawaii (0.27%)

(https://wallethub.com/edu/states-with-the-highest-and-lowest-property-taxes/11585)

The assessed value of the property is the value determined by the government upon which taxes will be assessed. The assessed value varies dramatically by county. Some counties will find the fair market value by finding sales of comparable properties, then taking a specific percentage of the fair market value and calling it the assessed value, and others will just call the fair market value the assessed value. Our experience is that the assessed value is lower than the market value.

Property taxes are due at the beginning of each year for the previous year’s tax assessment. Here are the median tax bills for the same states listed above, which will give you a rough idea of what people are typically paying each year in property taxes in that state:

• New Jersey ($8,104)
• Illinois ($4,299)
• New Hampshire ($5,550)
• Connecticut ($5,746)
• Wisconsin ($3,308)
• Washington DC ($3,113)
• Louisiana ($840)
• Colorado ($1,647)
• Alabama ($572)
• Hawaii ($1,607)

(https://wallethub.com/edu/states-with-the-highest-and-lowest-property-taxes/11585)

You’ll notice that, although Hawaii and Washington DC have low property tax rates, their property tax bill is very high by comparison to other states with low property tax rates. This is due to the high median property value in those two states, which is almost $600,000.

DELINQUENT PROPERTY TAXES

Property taxes are crucial to county and municipal governments maintaining viability. Without property taxes, citizens would be without the most basic government programs.

But every year a large percentage of property taxes go unpaid. Many homeowners will pay their property taxes along with their mortgage, and the mortgage company will pay the property taxes each year. The mortgage company does this to protect their position by making sure that the property taxes get paid. But if the homeowner fails to pay the mortgage, then the property taxes also go unpaid. There are limitless other examples of why property owners fail to pay property taxes, but the reality is that 20 – 30 percent of property taxes are unpaid every year. That’s devastating for the county and its citizens.

So what can the county do?

The government has created a system that solves its problem almost immediately in what’s called “tax lien certificate investing.”

When the property owner fails to pay their property taxes, the county or municipal government places a lien against the property.  

A lien by definition is a claim against an item, which affects the ability to transfer ownership by another party, which utilizes that item as security for repayment of a loan, or other claim.

This isn’t just any lien, though. This is a lien issued by the government, which takes priority before all other liens and encumbrances.

The typical way that liens are prioritized is by chronological order of when the lien is issued. Typically, the mortgage company has a first position lien, then all other liens fall in order afterwards.

But because it’s the government, and they do whatever they want, no matter when the tax lien is issued it immediately becomes the first position lien. This becomes very important later.

Here is the state statute in Arizona, which describes this priority:

ARIZONA STATE STATUTE 42-17153: A [tax lien certificate] is prior and superior to all other liens and encumbrances on the property, except:

(a) Liens or encumbrances held by this state.

(b) Liens for taxes accruing in any other years.

When the county issues a tax lien against the property, they also charge a penalty to the property owner for being late, and the penalties are steep.

Here are a few state statutes that show their state-mandated penalty rates:

FLORIDA STATUTE 197.172: Real property taxes shall bear interest at the rate of 18 percent per year from the date of delinquency until a certificate is sold.

ARIZONA STATUTE 42-18053: All taxes bear interest from the time of delinquency at the rate of sixteen per cent per year simple until paid.

TEXAS STATUTE 34.21 (c): [The property owner shall pay] …the amount the purchaser paid for the property, the amount of the fee for filing the purchaser’s deed for record, the amount paid by the purchaser as taxes, penalties, interest, and costs on the property, plus a redemption premium of 25 percent of the aggregate total if the property is redeemed in the first year of the redemption period or 50 percent of the aggregate total if the property is redeemed in the second year of the redemption period.

Statistics show that the majority of these delinquent taxes will be paid by the property owner eventually. For single-family residential homes occupied by the owner, our experience is that they get paid off quickly, like within 90 days.

Any thoughts why that would be? We will discuss that more shortly.

Even though the county will likely receive the delinquent taxes, they need that money today. They can’t wait a year or five, as is sometimes the case.

In order to collect the money today and continue to function healthily, the county issues what’s called a tax lien certificate, which they offer for sale for the same amount that is owed to them by the property owner. In return for the purchase of the tax lien certificate, the county offers up all of the penalty that will be paid by the property owner, if they pay.

Let’s look at an example:

Let’s assume that it’s 2022 and a property owner owes $1,000 to the county for their property taxes from 2021. Let’s also assume that we’re in Florida where the state-mandated interest rate on tax liens is 18 percent.

After the final notice from the county to the property owner, and without a full payment of property taxes upon receiving that notice, the county then issues a tax lien certificate in the same amount that is owed to them; $1,000.

The county is then required to make a public notice of the sale of the tax lien certificate. Every state has different rules about how that notice is to be made, but most states require that it be posted online, in a newspaper, or physically at the courthouse. These notices will oftentimes be a large list of all certificates being offered for sale, and will include various details about the property, most of which won’t make any sense to us like property codes and information the county uses to identify properties.

The sale is typically a public auction that requires you to register in order to participate. Many of these auctions are online, which means that you can participate from anywhere that you have an internet connection.

Most auctions, however, are live and in person with auctioneers calling out item numbers for each certificate and allowing the public to compete for the certificates. The most common method for determining the winner for each tax lien certificate is called “bidding down the interest rate.” In Florida, for example, the starting bid is 18 percent, because that is the state mandated interest rate, then the bidding goes down until bidders are no longer willing to accept a lower interest rate.

When the winner is determined, the county assigns ownership of the tax lien certificate to the purchaser. The tax lien is technically still in the name of the county, which gives the tax lien its power, but the county assigns its interest and ownership in the tax lien through the tax lien certificate to the investor.

The interest immediately begins to accrue in the name of the new tax lien certificate holder.

What’s great is that the property owner, in most cases, doesn’t even know that the investor exists. They only know that the county has issued a tax lien against the property and that they have an accruing penalty that they need to pay to the county along with the delinquent property taxes.

When the property owner finally pays the delinquent property taxes plus the penalty to the county, the county checks their records, finds the tax lien certificate holder, and forwards the money directly to the tax lien certificate holder. This money is frequently sent by ACH directly to your bank account or may come in the mail in the form of a check.

At this point, everyone is happy. The county got their money when the investor bought the tax lien certificate at the auction, the investor is happy because they got their money back plus interest, and the property owner is happy because they didn’t lose their home when they were delinquent in the beginning.

And that’s the foundation of tax lien investing.

In the next video, we will talk about what happens when the property owner fails to pay the delinquent property taxes plus interest.