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What is Tax Lien Investing?

Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2024 • October 16, 2024 1:32 AM
OVERVIEW

If you're a new investor, it pays to explore all of your options. Learn how investing in a tax lien works, how this process is carried out, and what kind of returns it might provide.

Key Takeaways

  • Tax lien investing is an accessible option for individuals looking to diversify their investment portfolios.
  • Tax liens are placed on individuals or businesses that fail to pay property taxes.
  • You can purchase tax lien certificates at public auctions and may be rewarded with interest payments as property owners repay the debt over time.
  • Tax lien investments can be risky, as some homeowners may be unable to repay their debts or file for bankruptcy.

Tax lien investing

You may have thought that investing in real estate is beyond your financial means, but it could be more achievable than you thought. There are countless ways to invest in real estate, and tax lien investing is one of the most accessible options. Although this won't be the best path forward for every investor, individuals looking to diversify their investment portfolios may want to consider investing in tax liens.

What is tax lien investing?

A lien is a legal claim against an asset that is established when a property owner fails to pay the tax debts associated with that asset. In real estate, tax liens are placed upon individuals or businesses that fail to pay property taxes. The landowner or homeowner can typically only remove a property tax lien before its expiration if they repay the debt, along with any penalties and interest.

Property tax liens are initially placed on taxpayers by the local government, including a town, city, or county. While many governments retain rights to collect the tax debt themselves, demand has grown for tax lien certificates. Buying one of these certificates, usually at a public auction, means you take the responsibility for paying the municipality the taxes it's owed. You also assume the responsibility of collecting that debt from the property owner.

By selling a tax lien certificate to a third-party investor, the municipality receives a guaranteed payment for the late taxes, and investors willing to accept the risk will be rewarded with interest payments as property owners repay that debt over time.

Purchasing a tax debt

Prior to holding a public auction where tax liens will be sold, municipalities will publish the liens that will be for sale. This gives interested parties time to review the debt and research the properties before the auction starts. Some of these certificates represent relatively small amounts of unpaid property taxes — a few hundred dollars — but others represent a larger percentage of the underlying property's value. Some certificates that represent large values come with the indication that failure to repay the debt would result in foreclosure on the property.

There are two primary methods to auction off tax lien certificates:

  1. Accept a premium

Municipalities will set a price for their tax liens — which is typically the balance of the late, unpaid debt — and investors can bid any amount above that starting bid. Their return on investment will be the amount they collect from the property owner, in interest, that exceeds their bid.

  1. Accept the lowest interest rate

Following the "bid-down" method, potential investors will compete to bid the lowest stated interest rate on the tax lien. The winning bid will establish the interest rate that the investor receives from the property owner as they repay their debt.

TurboTax Tip:

Before investing in a tax lien, you should research your local laws and ask questions about the property, records, and market.

Tax lien investments can be risky

Many property owners will repay their debts in a timely fashion, following the initial debt repayment schedule. In these instances, investors will profit off the interest portion they collect that exceeds the price they paid for the debt at auction.

But, some homeowners will be unable to repay their debts or will file for bankruptcy. In these cases, investors may be able to recoup their investment in foreclosure proceedings. If their lien is significant enough, they may even be awarded rights to the property itself.

Property acquired through foreclosure will pose its own set of problems (for example, it can be costly to renovate, or it can be difficult to enforce an eviction), but investors may still see a positive rate of return, or make money, when taxpayers fail to satisfy their debts.

Because the outcomes of the debt repayment can vary wildly, tax liens are notoriously risky investments. You should perform sufficient due diligence by researching your local laws before investing in this option.

Questions to ask before investing in a tax lien

Each jurisdiction is unique, so research your state's tax lien laws before you decide to invest. Ask yourself the following questions:

  • The property
    • When was the property last valued?
    • Has the condition of the property changed since its most recent valuation?
    • Where is the property located?
    • Is there a chance the demand for property in this location will change?
    • Is the property located in an area where foreclosures are common?
    • What other liens are on the property?
  • The records
    • Were all procedural requirements followed when the lien was established?
    • Have there been partial payments on the outstanding debt?
    • What is the length of the redemption period?
    • What is the maximum interest rate permitted by the state?
  • The market
    • What is the current market rate of return for tax liens?
    • How familiar am I with the housing market in this area?
    • What does my competition look like, and how much experience do they have investing in tax liens?

If the responsibility of researching liens and taking on tax debt isn’t for you, you may be able to invest through tax lien investment funds instead.

Passive investment

An investment fund is simply a collection of assets that multiple investors can buy into. Though they may not be as common as mutual funds or index funds, there are funds composed solely of property tax debt.

The fund manager researches investment options on behalf of the investors and selects which liens to purchase. The fund manager is also the one to file the required paperwork, track the redemption period of each lien, and inform property owners of repayment schedules.

Because individual investors are paying for somebody else to carry out administrative tasks, their potential return will be smaller than if they ventured out on their own. Investing in such a fund offers the benefits of diversifying your investments without the high costs associated with purchasing your own variety of tax liens.

Investors who want to dip their toes into the real estate market may find success by starting with tax lien investing. If you're familiar with the risks and understand the tax consequences of this investment, tax lien investing may be just the thing to bring into your portfolio.

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  • More self-employed deductions: based on the median amount of expenses found by TurboTax Premium (formerly Self Employed) customers who synced accounts, imported and categorized transactions compared to manual entry. Individual results may vary.

  • TurboTax Online Business Products: For TurboTax Live Assisted Business and TurboTax Full Service Business, we currently don't support the following tax situations: C-Corps (Form 1120) and entities electing to be treated as a C-Corp, Trust/Estates (Form 1041), Tax Exempt Entities/Non-Profits, returns that require more than 5 state filings, and other issues unrelated to the preparation of a tax return or unrelated to business income/franchise taxes. TurboTax Live Assisted Business is currently available only in AK, AZ, CA, CO, CT, DE, FL, GA, ID, IL, KS, MA, MD, ME, MI, MN, MO, NC, NJ, NV, NY, OH, PA, RI, SD, TN, TX, UT, VA, WA, WV, and WY.

  • Audit Defense: Audit Defense is a third-party add-on service provided, for an additional fee, by TaxResources, Inc., dba Tax Audit. Audit Defense is included at no added cost with business returns filed with TurboTax Live Business (excluding Sole Proprietor). See Membership Agreements at https://www.intuit.com/legal/terms/ for service terms and conditions.

TURBOTAX DESKTOP GUARANTEES

TurboTax Desktop Individual Returns:

  • 100% Accurate Calculations Guarantee - Individual Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we'll pay you the penalty and interest. Excludes payment plans. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement for details.

  • Maximum Refund Guarantee / Maximum Tax Savings Guarantee - or Your Money Back - Individual Returns: If you get a larger refund or smaller tax due from another tax preparation method by filing an amended return, we'll refund the applicable TurboTax federal and/or state software license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement for details.

  • Audit Support Guarantee - Individual Returns: If you receive an audit letter from the IRS or State Department of Revenue based on your 2024 TurboTax individual tax return, we will provide one-on-one question-and-answer support with a tax professional, if requested through our Audit Support Center, for audited individual returns filed with TurboTax Desktop for the current 2024 tax year and, for individual, non-business returns, for the past two tax years (2022, 2023). Audit support is informational only. We will not represent you before the IRS or state tax authority or provide legal advice. If we are not able to connect you to one of our tax professionals, we will refund the applicable TurboTax federal and/or state license purchase price you paid. This guarantee is good for the lifetime of your personal, individual tax return, which Intuit defines as seven years from the date you filed it with TurboTax Desktop. Excludes TurboTax Desktop Business returns. Additional terms and limitations apply. See License Agreement  for details.

  • Satisfaction Guarantee/ 60-Day Money Back Guarantee: If you're not completely satisfied with TurboTax Desktop software, go to refundrequest.intuit.com within 60 days of purchase and follow the process listed to submit a refund request. You must return this product using your license code or order number and dated receipt. Desktop add-on products and services purchased are non-refundable.

TurboTax Desktop Business Returns:

  • 100% Accurate Calculations Guarantee - Business Returns: If you pay an IRS or state penalty or interest because of a TurboTax calculation error, we'll pay you the penalty and interest. Excludes payment plans. You are responsible for paying any additional tax liability you may owe. Additional terms and limitations apply. See License Agreement  for details.

  • Maximum Tax Savings Guarantee - Business Returns: If you get a smaller tax due (or larger business tax refund) from another tax preparation method using the same data, TurboTax will refund the applicable TurboTax Business Desktop license purchase price you paid. Additional terms and limitations apply. See License Agreement  for details.

  • Satisfaction Guarantee/ 60-Day Money Back Guarantee: If you're not completely satisfied with TurboTax Desktop software, go to refundrequest.intuit.com within 60 days of purchase and follow the process listed to submit a refund request. You must return this product using your license code or order number and dated receipt. Desktop add-on products and services purchased are non-refundable.

TURBOTAX DESKTOP DISCLAIMERS

  • Installation Requirements: Product download, installation and activation requires an Intuit Account and internet connection. Product limited to one account per license code. You must accept the TurboTax License Agreement to use this product. Not for use by paid preparers.

  • TurboTax Desktop Products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for e-filing state returns. E-file fees may not apply in certain states, check here for details. Savings and price comparison based on anticipated price increase. Software updates and optional online features require internet connection. Desktop add-on products and services purchased are non-refundable.

  • Fastest Refund Possible: Get your tax refund from the IRS as fast as possible by e-filing and choosing to receive your refund by direct deposit. Tax refund time frames will vary. The IRS issues more than 9 out of 10 refunds in less than 21 days.

  • Average Refund Amount: $3,207 is the average refund amount American taxpayers received in the 2024 filing season based upon IRS data as of February 16, 2024 and may not reflect actual refund amount received.

  • TurboTax Technical Support: Customer service and technical support hours and options vary by time of year.

  • Deduct From Your Federal Refund: Individual taxes only. Subject to eligibility requirements. Additional terms apply. A $40 Refund Processing Service fee applies to this payment. method. Prices are subject to change without notice.

  • Data Import: Imports financial data from participating companies; Requires Intuit Account. Quicken and QuickBooks import not available with TurboTax installed on a Mac. Imports from Quicken (2022 and higher) and QuickBooks Desktop (2023 and higher); both Windows only. Quicken import not available for TurboTax Desktop Business. Quicken products provided by Quicken Inc., Quicken import subject to change.

  • Live Tax Advice: Access to tax experts to obtain answers to tax questions and to assist with tax year 2024 return(s) prepared with TurboTax Desktop software. Additional fees apply. Must be purchased and used by October 31, 2025. Excludes TurboTax Desktop Business. See License Agreement for details.

  • Audit Defense: Audit Defense is a third-party add-on service provided, for a fee, by TaxResources, Inc., dba Tax Audit. See Membership Agreements at https://turbotax.intuit.com/corp/softwarelicense/ for service terms and conditions.

All features, services, support, prices, offers, terms and conditions are subject to change without notice.

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