What Financial Advisors Should Know About Tax Lien Investing
As investors increase their knowledge and venture out to take more control of their portfolios, financial advisors are also learning to provide more value. While some investors have just enough knowledge to be dangerous, they tend to want something outside the ordinary. For one thing, they’ve learned that investing in real estate can be more than just buying and selling property.
One such example – tax lien investing. Your clients may be asking about it because they’ve heard it has major profit potential without a ton of risk. But does it really?
Above average return potential. The allure of tax lien investing is its reputation for great returns. An investor can purchase a tax lien certificate – ideally in the amount of a property’s tax debt – and then collect interest on that amount during the redemption period, which varies by state. When the homeowner pays the debt, the investor collects his or her initial investment plus the accrued interest. Depending on the state, that interest rate could run up to 18%!
Diversification. Investors are often looking for protection against stock market volatility. Investing in real estate is a good way to go, and tax liens can further diversify a portfolio with something many investors may consider fresh and different.
Low initial investment. The cost of a tax lien can run the gamut, starting with just a few hundred dollars. This may be a draw for clients who just want to get their feet wet in tax liens or don’t want to take on a lot of risk. An investor can put down a relatively small amount of capital to get in the game.
Things to Consider
The bid. Tax lien certificates are typically purchased at auction, either live or online. Novice tax lien investors may get wrapped up in the bidding process and either overbid or “bid down” the interest rate too low, depending on the bidding method in use. This will cut into the investment’s earnings and lead to a lower payout when the property is redeemed.
The underlying property. Many investors assume that the property owner will fail to pay the debt and then they’ll acquire a dirt-cheap property to sell for a healthy profit. This is not often the case; over 90% of the time the homeowner will redeem before the tax lien certificate holder can foreclose. Even in a case where the homeowner does not redeem, there’s a chance the property is in a neglected state or simply worthless, leaving no way to recoup the initial investment.
Compliance. For tax purposes, tax lien investing is a passive investment. However, an investor may still have work to do. Tax lien certificate holders may be required to send certain notices to the property owner. They also need to keep track of the length of the redemption period and the amount of time they have to initiate the foreclosure process in the event the homeowner fails to redeem. The foreclosure process may also add more hassle.
Furthermore, when using a Self-Directed IRA to invest in tax liens, all costs and income from the investment must run through the IRA. A good way to manage expenses and have cash available when it’s needed at auction is with a Self-Directed Administrator that understands the process, such as iPlanGroup. Be sure to contact us to learn how we help investors prepare for auction with their Self-Directed IRA funds.
The Bottom Line
Plenty of investors have profited well from tax lien investing, but due diligence is key. Savvy clients can be successful as long as they’re willing to put the time in, which means researching underlying properties to be certain of their value and making sure they understand the auction process in order to make competitive bids. Another option could be to engage a tax lien service provider to do the heavy lifting. If a client does decide to invest in tax liens, a Self-Directed IRA can provide the tax-advantaged capital resources to move forward. iPlanGroup makes the Self-Directed IRA investment process more seamless. We are glad you are taking steps to learn more about the Self-Directed IRA process with iPlanGroup. Let us show you why so many financial advisors trust us to take care of their clients.