Why Invest in Tax Liens with Your Self-Directed IRA?
Chances are if you’re thinking about investing in real estate, you’re thinking about buying property. For most of us, it’s our first foray into the world of real estate investing. However, new opportunities may be found with tax liens. Tax lien investing has been around for years, but it is gaining popularity with all levels of investors. With a little knowledge it’s not so intimidating either.
Investing in tax liens is one of the many way Self-Directed IRA owners can invest in real estate, and the returns can be significant, depending on the state you invest in and the property itself. As with any investment, there are risks involved with tax lien investments. Understanding what is involved is important to know and critical to your success.
What is a Tax Lien?
When a property has fallen behind on tax payments, it starts to accrue interest and possible penalties on the debt. Eventually, the county or municipality in which the property is located will file a tax lien. If the property owner hasn’t paid off the debt within a certain amount of time, the governing agency will sell the tax lien.
Tax liens are typically sold in an auction format. The bidding for a tax lien certificate starts at the total amount owed by the property, and participants either bid up the price or bid down the interest rate, depending on the method used. If you are the winning bidder, you now own the property’s debt. The property owner has a certain amount of time – a redemption period that varies by state – to pay off the indebtedness.
The Benefits of Tax Lien Investing in a Self-Directed IRA
The popularity of tax liens boils down to one thing – returns. During the redemption period, interest as well as potential penalties accrue on the debt. Depending upon the state in which the property is located, the maximum interest rate can be as high as 18%! That’s a pretty solid return on investment. Once the property owner pays the debt and redeems the property, you collect your original investment plus that accrued interest and any penalties. Of course, the interest that you actually earn depends upon if, and how much, you bid down the interest rate during the auction process.
The earnings potential doesn’t end there. Although, statistically, homeowners do generally pay off the debt within the redemption period, sometimes they don’t. In this case, you may now foreclose on the property and sell it. Ideally, you’ve acquired a property for the amount of its tax debt, which you can now sell at a healthy profit.
Fortunately, a Self-Directed IRA allows you to diversify your portfolio with alternative investments such as real estate; and any earnings from investments like tax liens grow tax-deferred or tax-free! Furthermore, you don’t need deep pockets to invest in tax liens. Tax liens can start at just a few hundred dollars. Just remember, as with any self-directed IRA investment, all costs and income from tax liens must run through your IRA.
While tax liens can be profitable, they are also a complex investment that may not be a wise choice for beginner investors. A novice can easily get wrapped up in the bidding process and overbid, cutting into the investment’s earnings. Furthermore, there is often a reason why homeowners don’t pay their taxes; the underlying property may be in a neglected state. If a homeowner doesn’t pay the debt and you have to foreclose on the property, you may not be able to recoup your initial investment by selling the property if it’s worthless. Sometimes the foreclosure process itself also adds another level of complication.
It’s important to do your homework before investing in tax liens. Successful investors are the ones who research the available properties to find those most promising and determine their true market value. It’s also important to have a solid understanding of the auction process in order to make effective bids. But for those investors willing to put in the time, tax lien investing can be a great way to make the most of a self-directed IRA.
Be sure to reach out to us at firstname.lastname@example.org with your questions on the tax lien investment process when using your iPlanGroup Self-Directed IRA account, You can also schedule your free 30 minute IRA Strategy Session here.