Purchasing Tax Liens with a Self-Directed IRA

Many people are unaware of the investment potential and returns that can be earned when investing in tax liens and tax certificates. Every year, counties across the United States have a sale where any unpaid property tax bills from the last tax period are auctioned off within those particular counties. For various reasons, property owners neglect to pay their property tax bills on time, and counties seek to recover this lost revenue by selling the rights to collect under those bills to investors via an auction sale. The investors are secure in the knowledge that their investment is a lien against the subject property.

Tom is one investor seeking a safe investment that will yield a decent rate of return. Tom has a self-directed SEP-IRA with $100,000 that he wants to invest into tax certificates. Tom researches his local county and finds it is having its annual tax certificate sale and auction in the next few weeks.  When reading about how the auction process works, Tom realizes the auction takes place online. Additionally, the bidders compete with each other by bidding down the interest rate that will be charged to the property owner who will want to eventually pay off the tax lien. For example, the county may set the default interest rate at 18 percent, but certain bidders may be willing to accept eight or nine percent instead. The winning bidder is the one who has offered the lowest acceptable interest rate.

The first thing Tom does is find out which tax liens in his county are going up for bid, and identifies the properties he thinks would be good investments.  Tom understands that if for some reason a tax lien is not paid off within the statutorily determined time frame (usually two years), then Tom’s IRA, as a valid lien-holder, may move to foreclose on the property. This means that Tom’s IRA will then have the right and title to the property on which it holds a tax lien. This type of scenario is rare, but nonetheless possible when bidding on tax liens.  This is not a bad thing, as Tom can turn around and sell the property and make an even larger profit than he originally intended.  However, he wants to make sure that the properties for which he seeks tax liens against are actually viable for profitable resale.  Tom also wants to make sure none of the property owners are in bankruptcy proceedings, as creditors and the IRS take precedence over tax liens.

To get started with the actual bidding process, Tom needs to get a Tax Identification Number (TIN) for his IRA account from the IRS, as the legal owner of the tax liens he purchases will be his Advanta IRA. Tom will specify his Advanta IRA as the owner and use the TIN instead of his Social Security Number when filling out the online form required to bid on tax liens.  Once he has that number, Tom goes to the county’s website and sets up a user name and password for his IRA account in order to bid online. In many cases, bidders on tax liens are required to put down an initial deposit prior to the date that the auction starts. Tom contacts Advanta IRA and submits a Buy Direction Letter, instructing Advanta to make a $10,000 deposit to his online bidding account. Tom gives Advanta his log-in information so his representative can go into his account and make the ACH transfer of $10,000. Once the deposit has been made, Tom logs in and begins entering his bids (i.e., what interest rate he will charge) for the liens on various properties.

When the online bidding process is complete, Tom is notified by the county as to which tax liens he won during the auction and what additional monies he must transfer to the county to complete the purchase of the tax liens. Tom presents another Buy Direction Letter to Advanta IRA, instructing submission of the balance due to the county via his online account. Again, a representative from Advanta logs in to Tom’s online account and submits the ACH deposit to the county for the balance due to purchase the liens.

Now that liens have been purchased and are held in the name of Tom’s IRA account, Tom awaits the payments due for the liens. As each tax lien is paid off, the county insures proper payment is made by the property owner (the original amount of the lien plus interest to-date that Tom’s IRA is entitled to), and forwards the monies to his IRA account. In Tom’s case, over the course of six months, all the property tax liens are paid off. Tom’s Advanta IRA earns an average of 12 percent on its tax liens, meaning that in only six month’s time, Tom increased the value of his IRA from $100,000 to $112,000. Tom now has $112,000 to work with for the next round of tax-lien auctions, and assuming his IRA earns another 12 percent over six months on that $112,000, his IRA account value will increase to $125,440. So, in a year’s time, Tom’s IRA has earned over 25 percent in income by investing in tax liens!

Tax liens can be a great investment for all types of accounts, large and small. They offer investors the ability to receive a set rate of return on their money because the interest rate is fixed and will not rise or fall with the economy. The investment is secure as it is a valid lien on a parcel of real estate.  The added bonus is the possibility that the IRA will receive no payments on the tax lien, and eventually will be able to foreclose on the property, yielding the investor a much larger rate of return than he or she had anticipated.  As with any venture, always perform due diligence in researching the pros and cons.  Make sure that you are not only knowledgeable, but comfortable with the decisions you make – and the chances you take – regarding your investments.