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Make Money Buying Tax Liens
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Investing in tax liens can add real estate exposure to your portfolio — without actually owning the property. However, experts say the business is complicated and warn that new investors can easily get burned. What you need to know about investing in tax lien certificates, including how it works and the risks involved.
A tax levy is a legal requirement for a municipality or local authority to place an individual on their property if they do not pay property tax. This notice usually comes before the Internal Revenue Service (IRS) or local or municipal governments take more drastic action, such as a tax levy, which can effectively seize someone's property to pay off the debt.
After the municipality issues a tax lien to the delinquent property owner, they create a tax lien certificate that shows how much tax they owe, along with interest and penalty payments.
To recoup unpaid tax dollars, municipalities can sell the deed to private investors who run the district in exchange for the money, including interest, and the right to collect interest from property owners when they pay off their balances.
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Currently, 28 states allow delinquent property tax liens to be transferred or assigned to the private sector, according to the National Tax Lien Association, a nonprofit that represents governments, institutional investors and servicers. This is the type of process.
Tax-paying investors must bid for the certificates at auction, and how this works depends on the specific municipality. Prospective investors should start by familiarizing themselves with the local environment, advises the National Tax Mortgage Association. Check with your local tax office to find out how these taxes are collected.
Auctions can be online or in person. Sometimes the winning bid goes to the investor willing to pay the lowest interest rate, known as a "reduced interest rate." The municipality sets the maximum interest rate and the bidder with the highest interest rate wins the tender. However, remember that when interest rates go down, so does your income.
Other winning bids are awarded to whoever pays the most money or prize over and above the mortgage amount.
Delinquent Property Tax
For investors, what happens next is not what happens in a stock. The winning bidder must pay all taxes owed, including interest and penalties. The investor then has to wait until the property owners repay the entire balance – if not.
Most homeowners have what's called a "payback period" -- usually one to three years -- before taxes and interest are paid in full. But if the homeowner defaults on the tax lien, the tax lien holder is responsible for starting the lien payment that allows the investor to take ownership of the property.
If you get a mortgage at auction, you should also learn about your responsibilities. For example, in Illinois, you must notify property owners that you have a lien and owe it within four months of buying a lien, says Joanne Moses, investment advisor and founder of TaxLienLady.com. Then another letter should be sent before the payment deadline.
Experts recommend considering the risks involved before investing in tax credits. While some investors may be rewarded, others face complex rules and loopholes that can lead to heavy losses in the worst case scenario.
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In terms of income, most investors make money based on interest on taxable income. Transfer rates vary by jurisdiction or state. For example, according to the National Taxpayers Association, the maximum legal interest rate is 16 percent in Arizona, 18 percent in Florida and 12 percent in Alabama.
However, profits during trading are not always so high. As a result, most tax liens purchased at auction sell for 3 percent to 7 percent nationally.
Richard Rampell, former managing director of Rampell & Rampell, an accounting firm in Palm Beach, Florida, experienced this before he retired. Rampell was a small part
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