# What Is a Tax Lien Certificate? How They're Sold in Investing

![Tax Lien Certificate: A document that represents a legal claim against a property with unpaid property taxes.](https://www.investopedia.com/thmb/_wT_TWUPeN7duSshBp4y6crqFHA=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/taxliencertificate.asp-final-b2b6b823202f45b9ab56efc51304ed44.png)

*— Investopedia / Zoe Hansen*

## What Is a Tax Lien Certificate?

A tax lien certificate represents a claim against a property due to unpaid property taxes. When an owner fails to pay [property taxes](https://www.investopedia.com/terms/p/propertytax.asp), the local government can place a lien on the property. If the taxes remain unpaid, the lien may be sold to investors through an [auction](https://www.investopedia.com/terms/a/auction.asp). Investors who purchase these certificates can earn returns via interest and penalty fees paid by the property owner when they eventually settle the tax debt. If the owner defaults, the investor may have the opportunity to foreclose on the property.

### Key Takeaways

*   A tax lien certificate is a claim against a property due to unpaid property taxes, which investors can purchase through auctions.
*   Tax lien certificates offer potential rates of return ranging from 6% to 24% because of high state-mandated interest rates, but investor returns are not guaranteed.
*   Buying a tax lien certificate can be risky, as the investor may face complications like overbidding or bankruptcy filings by the property owner.
*   Tax lien investing involves significant due diligence and research since it lacks liquidity and carries potential legal complexities.
*   Tax liens have priority over mortgage liens in the event of a property foreclosure, making them an attractive option for some investors seeking entry into real estate markets.

## How Tax Lien Certificates Work

A tax lien can be placed on a property because the owner hasn't paid property taxes. The county or municipality will issue a property tax bill each time property tax comes due and it will eventually issue a tax lien if the bill isn't paid.

The lien is removed when the owner pays the taxes but the municipal or county authority will eventually auction the lien off to an investor if they continue to go unpaid. A certificate is issued to the investor detailing the outstanding taxes and penalties on the property after they've placed a winning bid. The investor will then pay the taxes on behalf of the property tax owner but now they have the lien rather than the government.

Not all states, counties, or municipalities offer tax liens. Some states such as California only hold tax sales on defaulted properties, resulting in the winning bidder becoming the legal owner of the property in question.

Tax lien certificates usually last from one to three years, allowing investors to collect unpaid taxes plus interest ranging from 6% to 24%, depending on local laws.

> **Fast Fact**
>
> Tax lien certificates can be bid on and won based on the highest cash amount, the lowest interest rate, or another method.

## The Auction Process for Tax Lien Certificates

The tax lien certificate sale begins when the local government sends tax bills, and a property lien is placed if taxes are unpaid. This lien is then entered in an auction that's typically held online or in person. Bidders usually have to register and provide a deposit before participating.

At the auction, investors bid to pay the unpaid taxes plus interest and fees, with the winner receiving a lien certificate for the amount paid. The property owner then has a period of time to redeem the lien certificate from the investor by paying the amount owed plus interest and fees. The investor is typically able to foreclose on the property and take ownership if the owner fails to redeem the certificate.

> **Important**
>
> A property must be considered tax-defaulted for a minimum period that depends on local law before it's subject to the lien and auction process.

## Potential Returns from Investing in Tax Lien Certificates

Tax lien certificates often provide higher [returns](https://www.investopedia.com/terms/r/rateofreturn.asp) than other investments due to high state-mandated interest rates. Tax liens generally have precedence over other liens, such as mortgages.

If the property owner doesn't pay, investors might acquire the property for very little, though this is rare since most tax liens are redeemed before [foreclosure](https://www.investopedia.com/terms/f/foreclosure.asp).

The rate of return on tax lien certificates isn't guaranteed and can vary depending on whether the property owner redeems the certificate and whether the investor can foreclose on the property.

## Pros and Cons of Investing in Tax Lien Certificates

Buying a tax lien certificate can be an attractive [investment](https://www.investopedia.com/terms/i/investment.asp). Some certificates have a low entry point so you can buy them for a few hundred dollars. Compare that to a traditional investment like a [mutual fund](https://www.investopedia.com/terms/m/mutualfund.asp) that often comes with a minimum investment requirement.

You can buy multiple low-cost certificates, usually offering consistent returns without market volatility concerns. 

A downside is that investors must pay the certificate's full amount quickly, usually within one to three days. These certificates are also highly illiquid because there's no secondary trading market for them. Those who invest in tax lien certificates must also undertake significant due diligence and research to ensure that the underlying properties have an appropriate assessed value.

## Understanding the Tax Implications of Tax Lien Certificates

Tax implications vary based on several factors and may include federal, state, or local taxes.

The income earned may be subject to taxes if an investor gains interest on a tax lien certificate. Interest income is typically reported on the investor's tax return in the year it's earned. The taxpayer must report the interest income as taxable income even if they didn't receive any cash distributions.

If the owner redeems the lien by paying owed amounts, the investor gets the repayment plus earned interest. This amount is considered a return of [principal](https://www.investopedia.com/terms/p/principal.asp) and it isn't taxable income.

The investor can take possession of the property through foreclosure if the property owner is unable to redeem the tax lien certificate. The investor will then become responsible for paying taxes on the property going forward. Any income or gains earned from the sale or rental of the property will also be taxed, just as with any other property. Some states and localities may also impose taxes or fees on tax lien certificate investments.

## Tax Liens vs. Mortgage Liens

A tax lien and a [mortgage lien](https://www.investopedia.com/articles/credit-loans-mortgages/090816/it-bad-have-lien-your-house.asp) are both legal claims against a property but they're significantly different in a few ways. A tax lien is placed on a property by the government to collect unpaid property taxes. A mortgage lien is placed on a property by a lender to secure the loan used to purchase the property.

In a default, tax liens usually take priority, so they are paid before mortgage liens during foreclosure. The individual or lender who owns a mortgage lien is more at risk of losing their principal investment and not receiving any funds.

Property owners have the right to redeem a tax lien by paying the unpaid taxes plus any interest or fees owed. Mortgage liens can typically only be satisfied by paying off the entire underlying loan. Both liens are similar in that they represent debt that may be repaid but the underlying nature of that debt is different.

Tax liens are typically placed on a property for a specific time. A local government entity may wish to sell the lien to an investor through a tax lien certificate sale after that time has passed. Mortgage liens can last for the duration of the mortgage loan which may be significantly longer.

## Is Tax Lien Investing a Good Idea?

Property tax lien investing may be a plausible investment for those who want to hold alternative investments and want exposure to real estate. It's a reasonable way for investors to own real estate without the necessity of holding tangible property. It's usually advised that you understand tax lien investing, know the local real estate market, and do research on properties before investing.

## What Is the Risk of Tax Lien Investing?

There are several downsides to tax lien investing. It can be easy to overbid on tax lien properties or not fully understand the redemption periods. You may hold a lesser claim to other, more strongly perfected liens on the property. The major risk is that the property owner files for bankruptcy so they'll never have to repay the delinquent tax and the home may escape foreclosure.

## Does a Tax Lien Hurt Your Credit?

Having a tax lien against you doesn't necessarily hurt your credit because the three major credit bureaus don't include tax liens on their consumer credit reports. But property tax liens may be a matter of public record and the information that you owe an outstanding tax bill would be widely available to the general public.

## The Bottom Line

A tax lien certificate is a representation of ownership resulting from defaulted taxes owed on a property. A local government creates a lien against the property and can auction off the rights to that lien in the form of a certificate if the taxes continue to go unpaid.

An investor who purchases the tax lien certificate may be able to recoup their principal while also earning some interest via penalty fees should the original property owner be able to pay off the tax lien in the future. But returns are often a function of risk just like other forms of investment.

> **Article Sources**
>
> 1.  The National Tax Lien Association. "[Common Questions about Tax Liens](https://www.ntla.org/page/FAQ)."
>     
> 2.  State of California. "[Public Auctions and Bidder Information](https://sco.ca.gov/ardtax_public_auction.html)."
>     
> 3.  Tax Lien University. "[Tax Lien States That Sell Tax Lien Certificates](https://taxlienuniversity.com/learn/tax-lien-states-that-sell-tax-lien-certificates/)."
>     
> 4.  Fairway Independent Mortgage Corporation/The Wood Group. "[Tax Liens and Mortgages](https://woodgroupmortgage.com/articles/tax-liens-mortgages)."
>     
> 5.  Internal Revenue Service. "[Topic No. 403, Interest Received](https://www.irs.gov/taxtopics/tc403)."
>     
> 6.  Internal Revenue Service. "[Publication 550, Investment Income and Expenses (Including Capital Gains and Losses)](https://www.irs.gov/pub/irs-pdf/p550.pdf)." Page 20.
>     
> 7.  Rocket Mortgage. "[Tax Lien Investing](https://www.rocketmortgage.com/learn/tax-lien-investing)."
>     
> 8.  Experian. "[Tax Liens Are No Longer a Part of Credit Reports](https://www.experian.com/blogs/ask-experian/tax-liens-are-no-longer-a-part-of-credit-reports/)."