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How to Invest in Tax Liens & Deeds with Your Plan

Investing in tax liens and deeds can be a great way to aggressively grow your retirement savings. When done properly, tax-lien investing can produce above-average returns on a consistent basis.

Tax liens & tax deeds also have the advantage of being an asset class with a relatively low barrier to entry, since liens can be acquired for a as little as few hundred or a few thousand dollars. This allows investors to participate with limited capital, or for greater diversification for investors with more funds to work with.

Because tax lien investing is very popular with self-directed IRA and Solo 401(k) plan holders, we wanted to walk through some of the mechanics involved.

Understand the Strategy

When a property owner is delinquent on their property taxes, the taxing authority of the city or county where the property is located has the right to place a lien on the property to collect those taxes.

Different municipalities have different approaches to leveraging this lien authority as a way to remedy the deficiency. They may simply apply the lien with interest and penalties over a certain redemption period, which can range from a few months to several years.

Some localities will auction off the deed to the property as a means to collect tax revenue. In either case, the opportunity exists for investors to purchase the lien or deed rights, which provides the necessary cash flow to the municipality up front. In return, the investor may receive the interest and penalty income on a lien or first right of foreclosure on a deed at auction.

Research your Chosen Market

Because each locality operates differently, it’s important to spend time learning about the process, auction timelines, deposit and payment policies, and redemption methods of a market in which you’re interested in investing.

Some tax authorities hold periodic live auctions. Others may offer liens and/or deeds online, or via the county clerk’s office in an “over the counter” fashion.

One of the keys to success in this space is having a clear understanding of the procedural outline. Without this, you can have your money tied up for longer than desired, or even lose out on potential income if you fail to execute on your required actions in a timely fashion.

Setup Your Checkbook IRA or Solo 401(k) Plan

It typically takes 3-4 weeks to establish and fund a Checkbook IRA LLC or Solo 401(k) plan. If you intend on attending a tax auction, you need to plan ahead and get your plan setup in advance or you won’t be able to participate.

Register with the Auction

Many live auctions require pre-registration. Some may also require a registration fee or deposit. Be sure to understand your requirements and attendant timelines.

The registration must be made in the name of your IRA-owned LLC entity or Solo 401(k) trust, not in your own name. Any fees or deposits must be made with plan funds. The introduction of personal funds could create a self-dealing prohibited transaction with adverse tax consequences.

Prepare for Your Auction

In addition to understanding the mechanics of how a particular auction works, you need to research the lien or deed assets that will be available. Sources you may use to research properties include the following:

County Treasurer

  • Will have a list of properties available for auction.
  • These lists are usually available a few weeks in advance of an auction for live auction locales. This list is generally your best starting point.

County Assessor

  • The tax value of a property will be available from this source if not included on the treasurer’s list.
  • Keep in mind that tax value and market value can be different.

Valuation Sites

  • Working with a local realtor or a real estate data site such as Zillow can help you to identify an approximate market value for most property types.

County Recorder

  • This resource allows you to research any other liens than may impact a property.
  • Tax liens will generally wipe out most other forms of liens such as mortgages, but that may not always be the case.
  • Be sure to understand the laws as they apply in your target jurisdiction. A property with a lot of other liens may not be worth bidding on.

County Surveyor

  • Researching properties visually can be very helpful, and the surveyor’s office can provide plat maps and other aerial views.
  • Sometimes there are online tools for this kind of research that are available.
  • In many cases, properties may be useless due to lack of road access or other size and location factors.
  • If you’re investing locally, you always have the option of driving past a property.

Bid on Liens

The bidding process is another area where each taxing authority has its own process. Be sure to understand the bidding mechanism before attending an auction. Some of the common bidding formats are outlined here:

Price Bidding

  • This conventional auction format allows bidders to compete by raising the price they are willing to pay for a lien or deed.
  • Opening bids usually start at the amount of taxes, interest, and penalties outstanding at the time of auction.
  • In a lien auction, bidding above this amount will secure the rights to the lien but will reduce your overall yield from the investment.
  • In a deed environment, the bid amount represents what you are willing to pay if the property is foreclosed, and any amount above the tax and penalty balance reduces your potential equity in the property.
  • It would be counterproductive to bid an amount greater than the property is worth in these scenarios.

Interest Rate Bidding

  • Some states such as Arizona allow investors to compete by bidding down the rate of interest they’re willing to accept for a lien.
  • If the standard rate is 16%, bidders can offer to accept less.
  • The difference will accrue to the taxing authority.

Bid Premiums

  • Some localities that offer traditional price bidding auctions will implement a bid premium to prevent frivolous overbidding.
  • If the bid amount is greater than the property value, a certain percentage of the amount over value must be provided as a premium or deposit to the taxing authority.
  • Because this premium is held interest free by the county for the redemption period of the lien or deed, it’s a disincentive for overbidding.

Lottery

  • A handful of auctions are run on a lottery basis.
  • For each auctioned parcel a lottery number is drawn.
  • If the selected participant wants the property, they can generally win the auction with a minimal bid.
  • If they decline the parcel, the next lottery number is drawn.

Post-Auction Purchase

  • Some places will offer parcels for sale after the auction in some fashion if they aren’t sold live.
  • This can take the form of “over the counter” sales at the county clerk’s office or via a normal real estate sales listing offered by the taxing authority after they foreclose on a property.

Pay for Liens

The beauty of a self-directed IRA or 401(k) offering checkbook control is the ability to simply execute contracts and fund transactions immediately without 3rd party intervention. It’s nearly impossible to invest in tax lien auctions using a self-directed IRA custodian, where each investment transaction involves paperwork and processing delays to have the institution transact on behalf of your IRA.

When you hold plan funds in a bank account of your choice, you can act immediately (which is required in this space). You will, however, need to understand in advance what the payment policies of a particular auction are and prepare accordingly.

In some cases, you will make a deposit before the auction, and can do so electronically or with a debit card. Other times, you may need obtain a bevy of cashier’s checks made out from your plan account to the auction trustee. If you use them, fine. If not, you can return them to your plan account.

Another possibility is that if you’re the winning bidder, you have until a set time usually in the afternoon of the auction to produce funds, and can so do via cashier’s check or wire.

In all cases, you just need to ensure that all purchases are made directly from your plan account. The method of payment doesn’t matter. The proper flow of funds is of critical importance.

Wait out the Redemption Period

Most states have a procedure surrounding a redemption period. There is a statutory timeframe in which the property owner has the right to pay their tax and penalty obligations and prevent their property from being foreclosed. Redemption periods can range from a few months to a few years.

Receiving the Profit

If at any time during the redemption period the property owner pays their tax obligation, your investment will mature. Your plan will then receive the return of principal, as well as any interest and penalty income.

If the taxpayer doesn’t redeem, then the lien or deed will move to the foreclosure phase. Depending on how the jurisdiction operates, you may have first right to acquire the property, or have the option to be paid the amount of taxes and penalties owed from the bid amount a property demands when purchased by another party at auction.

All income produced by the investment accrues to the retirement plan, and must be deposited to your plan bank account.

Expense Considerations

If there are any expenses associated with research specific to plan investments, they should be paid with plan funds. The exception would be if you are planning to invest at a particular auction both with your plan and with non-plan funds. In that case, any use of plan funds that facilitates your personal investing could create a self-dealing scenario.

Keep in mind, you’re not an active employee of your IRA LLC or 401(k) trust. As such, you don’t want to be incurring expenses or being reimbursed personally. Your role is to direct the affairs of the plan and deploy the plan capital effectively.

We are often asked if the plan can pay for travel expenses in order to attend an auction. The reality is there is no IRS defined answer, which makes this a grey area of compliance.

It may be acceptable for very limited and infrequent travel expenses associated 100% with plan investments to be paid by the plan. However, any direct or indirect benefit from your plan to yourself can create risk of a prohibited transaction with severe tax implications.

If you were to visit a sibling or sneak in a round of golf while traveling to a tax auction, that could create such a risk. Our conservative opinion is that it’s probably best not to use plan funds for any personal travel expenses.

We would also recommend against using plan funds to pay for any training or courses you may desire to educate yourself on the process of tax lien investing.

A Powerful Way to Diversify Your Retirement Account

Investing in tax liens and tax deeds can be a great way to diversify your tax-sheltered retirement savings and produce good returns. Having a self-directed IRA or 401(k) retirement plan featuring checkbook control is a significant benefit when pursuing this type of investing.

Planning ahead and learning about how tax auctions are handled in various jurisdictions is critical to your success in growing your retirement savings with this type of investing.

Contact us today with any questions about investing your self-directed retirement plan in tax liens & deeds »

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