Tax Liens and Deeds in your IRA
Investing in tax liens and deeds has the potential to be quite lucrative. It is also possible to invest in tax liens and deeds with less capital than may be required for other investments such as rental properties. As such, this is one of the more popular investment choices for holders of Self-Directed IRA LLC and Solo 401(k) programs.
What are Tax Liens & Deeds?
Tax liens are a mechanism used by local governments to remedy the failure of a property owner to pay real estate taxes. Tax liens may be levied on any kind of property, from raw land to homes to commercial properties. The rules surrounding the type of lien and how such liens are issued and redeemed varies by state and by county. There are two main classes, tax liens and tax deeds.
A tax lien is issued immediately once they property owner has failed to pay their taxes. The lien applies a first position encumbrance on the property ahead of all other liens, including mortgages. Such liens are then offered for sale to the public. An investor purchases the lien, thus proving the municipality with the necessary tax revenue, and then has the right to the property. If the property owner pays their taxes, the investor generally receives interest which can be in the range of 12-18%. If the property owner fails to redeem the property prior to a time period set by law, then a tax deed foreclosure proceeding will be initiated, and the lien investor can choose to bid on the property or would be paid off on their lien if another party purchases the property.
Tax deeds are generally issued after the property owner has failed to pay back taxes for a period of time. Title to the property itself is placed up for public auction and the starting bid can be as low as the taxes owed – depending on the jurisdiction. Tax deeds usually have a short redemption period in which the taxpayer may resolve the debt and retain the property from a few days to a few months. If a property is redeemed, the investor will receive penalties and taxes. If the property is not redeemed, the investor may foreclose on the property.
Why Invest in Tax Liens & Deeds?
Tax liens and deeds provide the opportunity for generous return on investment, potentially with lower amounts of capital. While there are certain risk factors, they are relatively low. Tax lien investing is focused on the collection of interest and penalties (where available) for the tax debt. Tax deed investing is aimed at acquiring property at below market cost.
How to Invest in Liens & Deeds
The process for investing varies by state and by county. Most liens and deeds are sold at auction, with some auctions taking place in-person at a county courthouse, and some taking place online. You will generally need to register in advance for such auctions and may be required to place a deposit to participate.
Bidding can take place in one of several fashions, such as bidding up the price, bidding down the interest, or by lottery. In some jurisdictions, unsold liens or deeds may be available for sale “over the counter” from the county clerk’s office or website after an auction has been completed.
Prior to participating in an auction, you will want to perform research to identify those properties you may be interested in and ensure there are no complications such as other liens that may need to be settled or problems with the property itself that may create issues if you were to take over ownership.
If you are the successful bidder at auction, you will then need to pay for the lien or deed from your plan account, usually the same day. This may require the issuance of a cashier’s check or wire from your plan account.
You will then need to wait out any redemption period as allowed by law. This period is meant to give the property owner an opportunity to settle their debt with the taxing authority. With a lien, redemption means that your IRA or 401(k) will get a payday, with interest and any applicable penalties being paid. When a property is not redeemed, the process will then move to foreclosure.
The Advantage of Checkbook Control
Tax lien and deed investing is an area where checkbook control is a must. You need to be able to issue funds directly on short notice, both for a deposit which must be registered in the plan entity name, and if you are the winning bidder. With a Checkbook IRA LLC or Solo 401(k), you can directly make such payments from your plan account without delays or 3rd party fees. You can use a plan held debit card, obtain cashier’s checks, or issue wires as appropriate for the taxing jurisdiction. If you make a deposit and are not successful in bidding at auction, the deposit can simply be returned to the plan account without hassle.
The several days processing delay that comes with working directly via a self-directed IRA custodian just does not work in this space.
When investing in tax liens and deeds, you must ensure that all activities are conducted under the umbrella of your plan. You may not provide benefit to your plan such as by paying a necessary auction deposit with personal funds, for example. All expenses associated with tax lien investing must come from the plan account directly, as all income produced must be deposited to the plan account.
We are often asked if the plan can pay for the account holder to attend a tax lien training class, and recommend against that. Even if your investing activities will be 100% through your plan and not involve any personal investing in tax liens, the IRS could consider this self-dealing.
Investing in tax liens for the interest and penalty income will be considered passive and therefore fully tax sheltered to a self-directed retirement plan. This would also be true of acquiring a property via a tax deed and then holding that property as a rental. If your strategy will involve acquiring properties simply to turn around and resell those properties – with our without rehab – that could be viewed as a dealer activity. If executed on a regular basis, this would expose the IRA or Solo 401(k) to UBIT.
Investing in tax liens and deeds can be a good way to diversify your holdings and create generous return on investment. A checkbook IRA LLC or Solo 401(k) is certainly the superior tool for participating in this fast-moving asset class. If you have an interest in using tax-sheltered retirement funds for such investments, please feel free to contact us. One of our expert advisors will be happy to evaluate your specific situation and goals and provide appropriate guidance. Investor education is our top priority.
As with any investment, there is risk associated with investing in tax liens and deeds. Investors should have the financial experience to gauge and understand the risks, perform the necessary diligence, and properly administer such investments in compliance IRS rules.
Safeguard Advisors, LLC is not an investment advisor or provider, and does not recommend any specific investment. We provide self-directed retirement plan platforms that are properly structured per the tax code to provide you with full control over investment decisions. The information above is educational in nature, and is not intended to be, nor should it be construed as providing tax, legal or investment advice.