Imagine how investing a relatively small fee can earn between 10 – 30% returns within 2 to 4 years. Tax certificate investing is a unique way to invest in real estate without worrying about tenants or maintaining properties. 

It involves buying tax certificates, issued by the government on taxes owed by property owners in a bid to make a profit when the owner pays off that debt. And if they fail to pay off that debt you may have the right to foreclose the property significantly increasing your income potential.

It’s no wonder there’s a growing interest in tax sale investments, especially as US homeowners witnessed the biggest property tax increase in five years, at 6.9% in 2023.  Higher property taxes mean higher tax collections and property tax delinquencies. 

Often, tax lien sales create avenues where homeowners are provided more space to pay their taxes. And the government uses these tax lien sales as incentives to get them to pay. Also, even as there’s no nationwide view of how tax lien sales help, American homeowners owe over $22 billion in unpaid property taxes each year. Hence, tax certificate investing allows you to make significant profits against a small amount of money.  And the returns can be worthwhile if you do your due diligence. Here we’ll explore what are tax certificates, the rules, and pitfalls, and how you can make the best of this type of real estate investing. 

What is a Tax Certificate?

Tax certificates generally serve as a record of a property’s tax history. It details essential information such as assessed value, levied property, and outstanding tax liens. 

A tax lien is a legal claim the government (usually the local or municipal government) makes on a property when owners fail to pay their taxes within a given time. When a property has a lien attached to it, it can’t be sold or refinanced until the taxes are paid and the lien removed. 

Hence, the tax lien document helps real estate investors understand the ongoing tax burdens that the property has. 

What is Tax certification?

Specifically, tax certificates take on a different meaning in the realm of tax liens and sales. 

Here a tax certificate (also called tax certification or tax lien certificate) is an official document produced on the Tax Claim Bureau letterhead. It represents the unpaid taxes alongside interest and potential penalties. So, when a homeowner or landowner does not pay their property taxes, the government (city or county tax collector) places a lien and creates a tax certificate for that property.  

How Does Tax Lien Investing Work?

When the government places a tax lien on a property, it generally opens the opportunity for tax lien investing. 

The tax lien is technically a warning from the government to the property owner to pay their taxes within a specified period before the foreclosure process begins. So, that period before foreclosure usually jumpstarts the tax lien investment process. 

Ideally, as an investor, you’ll purchase and pay off the tax debt thereby lending the property owner money to pay their taxes.  When they pay within the specified amount of time, you’ll get the money you spent on the tax lien certificate, which includes taxes, interests, and then a set interest rate. It’s also possible to take possession of the property if the owner fails to pay off the due taxes, and the property forecloses after the specified redemption time. 

Presently, only 28 states comprising 2,500 jurisdictions in the US allow the selling of public tax debt such as tax lien certificates. Even so, the legal framework surrounding tax certificates varies from one state to the next. For example, some states allow investors to bid on the interest rate they will charge on unpaid taxes. Other states require only bidding on the upfront cash amount paid to the government. Many other rules and legal issues also vary from one state to the next. 

How to Get Started with Tax Certificate Investments

The process of tax certificate investing varies from one state to the next. So, it’s super important to actively seek out more education on tax sale investing to make the best of your investments. Most tax certificate investing requires the following steps.

Step 1: Look for auctions 

Alongside other real estate investors, you will bid to be awarded the tax lien certificate. You need to search online and in person for states and jurisdictions that auction tax lien certificates. Start local by contacting your city or county’s treasurer’s office to find out where the next auction is happening. 

The treasurer’s office will also provide you with a list of property liens scheduled to be auctioned, and the rules on what happens during the auction and the sales after. Other places to find tax liens for sales include local newspapers, tax revenue offices, and municipal websites.

Step 2: The bidding process 

Attend and try to win the auction on the tax lien certificate. Generally, the bidder with the lowest rate gets the certificate. Make sure to research and pick tax liens that are truly worth bidding on (more on this below). 

Step 3: Make payment

Now you need to pay the unpaid taxes and other fees. Often, you’ll need to do this immediately

Step 4: Wait time

Now you need to wait to see if the homeowner redeems the certificate. If they don’t within the specified time you need to move forward with foreclosure. 

Step 5: Repayment or Foreclosure 

If the homeowner redeems the certificate, you make your interest right away. Sometimes, the homeowner is unable to redeem. In this case, the property moves to foreclosure, where the real estate investor obtains the deed to the property. Here the tax lien certificate leads to a bigger investment return, where you own the property for a fraction of what it costs on the market. Still, you must do your due diligence to ensure you know what to expect. 

Benefits of Investing in Tax Certificates

Tax certificates can yield notable returns. Here are some benefits you can expect when investing in tax liens. 

Lower investment cost: Unlike many other forms of real estate investment, you don’t need to make a hefty down payment. Tax clients can cost as little as a few hundred dollars. 

Decent returns: With tax certificate investing, you know what type of returns to expect. Generally, these interest rates range from 10% to 30%. 

Excellent for diversifying: It’s also a great addition to your real estate investment portfolio. You can even make several investments into multiple tax certificates across different communities and jurisdictions. 

No tenancy or maintenance issues: Since you don’t own the property, you don’t have to worry about tenants or maintenance. That said there’s still some work you need to do.

Risks and Considerations

As with all kinds of investments, tax lien investments can be risky. Here are some drawbacks to consider.

Lengthy wait: You’ll need to wait for the given time specified by the government to get your money back. This usually takes about three years. 

Risk of nonpayment and foreclosure: The goal of tax certificate investing is getting your money back plus interest after the property owner pays. About 98% of homeowners usually redeem the property before the foreclosure process begins. Foreclosure often comes with time-intensive and complicated hurdles. 

Owner bankruptcy: If the homeowner declares bankruptcy, there’s a risk of being denied your claims. 

Expenses: If the property goes into foreclosure, there’s always a chance of making huge real estate returns. But that’s after paying the legal fees, foreclosure expenses, and maintenance costs. Often, there might be other creditors and the IRS involved, in this case, the tax lien won’t be paid until other real estate investors have been paid. 

How to Mitigate the Risks in Tax Lien Investing 

Now you’ve realized the pros and cons of tax certificate investing, here are some tips to help you minimize the risks of investing in tax certificates. 

Do your due diligence

As said before, you must do your due diligence to have a clear view of the kind of scenarios to prepare for. A good place to begin is reviewing the tax lien and its associated documents. When a property is assigned a lien, it’s also assigned a number you can look up online. Often this is a great way to figure out the ongoing tax burden. Looking up the parcel number online or in person at the local county allows you to view the property value, taxes, penalties, and possible HOA fees if the property falls under a homeowner’s association. You’ll also be able to see a description of the condition of the property, and structures located on it. You can also look up the property address and consider visiting to get a physical look. 

Quantify your risks 

Consider analyzing your risks by dividing the face value of the delinquent tax lien by the property’s market value. Higher ratios mean greater risks.  You should also determine other issues with the property. Find answers to the following questions:

• What is the probability of the owner redeeming the lien? 
• What’s the environment surrounding the property? 
• What kind of repairs might be done to the property if ever foreclosure happens? 
• What other liens does the property have? Does the property owner also have other creditors that might lay claim to the property?

Consider getting the property reassessed to help you determine the risks you’re dealing with. 

Understand the rules and regulations 

The process for tax liens sales varies from one state to the next. Actively seeking knowledge about the local laws, protocols for lien release, lien redemption periods, and how they apply to your investment is vital. You also need to learn how to communicate with property owners and navigate the process efficiently.

Decide on a type of property 

Never purchase tax certificates randomly. You need to determine the type of property you want to hold a lien on and stick to properties that fit the profile. That way, you have an idea of the risks associated with all of them.  There are varying levels of risks for holding liens on residential, undeveloped land, commercial, or property with improvements. 

Get familiar with the property associated with the tax lien

Always look up the real estate market conditions that directly affect that property. Generally, it’s advised to avoid properties with environmental damage, such as those with hazardous materials. You should also avoid abandoned or dilapidated properties which may not be a great buy even when the promised interest rate looks good. 

Be prepared to invest some active time 

Although you won’t maintain any property, you’ll still need to do some bit of work. For instance, after you’ve purchased the property lien, you’ll need to track down the owner and notify them in writing about your purchase and the stated amount of repayment time. You also need to send a second letter of notification near the end of the repayment time, if they’ve not paid in full yet. 

Take note of your tax liens expiration date

Most tax lien certificates have expiration dates. If the lien expires, you may become unable to collect any unpaid balance. So, you need to be proactive about the steps you take to make the best of your tax lien investments. 

Conclusion

We’ve explored the basics of what is a tax certificate and the potential for high returns. Remember, success requires careful research and a strategic approach. Laws and regulations also vary from one County or jurisdiction to the next. So we recommend active learning and keeping up with the new laws and regulations governing tax certificate investing in your target state or county. 

When you have the right knowledge, tax certificate investing can be a powerful tool in your investment arsenal. Do you already invest in tax certificates? Share your experiences in the comments below. 

Are you new to tax lien investing? Sign up for our Free Masterclass that deep dives into everything you need to know to build smart investment strategies that explore this opportunity.

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