What is a Tax Lien?

Tax lien example

If you’re new to real estate investing, you may be wondering about tax sales or have come across a property with a tax lien on it found during a title search. Some consider buying tax certificates or any property with a tax lien too risky, while others prefer to roll the dice and hope their gamble pays off.

For homeowners, a real estate tax lien can be a huge burden, but getting rid of it doesn’t have to be complicated.

We’re going to break down what a tax lien is, how it affects homeowners and taxpayers, steps to avoid a lien, and what to do if you have one. Then, for real estate investors, we’ll discuss what a tax lien means for your investment opportunities.

What is a tax lien?

The Internal Revenue Service (IRS) is responsible for issuing federal tax levies and liens. If you’ve ever had an IRS tax lien, you know how stressful it can be. A tax lien is a legal claim against your property when you don’t pay your taxes to the government. This means that until you settle your federal tax debt, the government has an interest in your property, including real estate, personal property, and financial assets.

These tax liens can be filed for failing to pay federal income taxes. You can also have liens from local government agencies for failing to pay local individual income or property taxes.

How does a tax lien work?

When the government files a federal tax lien, they become a creditor. Essentially they’re saying they get the first claim above anyone else with a financial claim on your assets. So any money you would make from selling property or other assets would go to the government before anyone else, including you.

What will happen first is your failure to make your required tax payments. Once you miss filing, the IRS sends a notice letter essentially demanding you pay what it is owed for that tax year.

Let’s say, for whatever reason, you don’t pay the tax or try to work it out with the IRS. Now the IRS can file a Notice of Federal Tax Lien, a public document that alerts creditors that the government has the first legal right to your assets. The tax lien attaches to your owned physical assets like real estate holdings, vehicles or financial assets like securities.

Note that if you buy new assets while a tax lien is filed against you, such as a new car, that can also go under the tax lien.

A tax lien is not a tax levy. A levy allows the government to seize assets, such as wages and bank accounts. A lien simply says the IRS has a legal claim to it.

What are tax lien certificates?

Tax lien certificates are documents issued by a government agency (usually the county treasurer) to cover unpaid taxes on a particular property. The certificate documents what is owed, plus penalties and interest.

In 29 states plus the District of Columbia, the local governments are allowed to auction these certificates to private investors who pay the tax bill in exchange for the right to collect the owed money, plus interest, from the property owners. We’ll explain more about tax lien auctions and their implications for real estate below.

How does a tax lien affect you?

A tax lien can have severe consequences for taxpayers and homeowners alike. Although the three major credit reporting agencies have stopped reporting federal tax liens on credit reports, it could still chase you for years even if it doesn’t drop your credit score.

Want to buy a property or sell yours? Tax liens still appear in title searches. Having one can limit your ability to qualify for credit or loans from traditional lenders. When they see the government could have the first claim on the debt, that increases the lender’s risk of losing their investment should you fail to make regular payments to them.

Additionally, it could make refinancing or selling your home difficult as you’ll need to use the profits first to pay off the debt. Buyers may also back out of the deal as they don’t want to assume any ownership of your tax lien. You’ll need to clear the property before selling, even if it’s a probate sale.

When you do go to sell an asset, like your home, the government’s tax lien is how it recoups delinquent taxes. So any profits you would have made on the sale go to Uncle Sam first and above any other creditors.

The IRS also does have the legal authority to seize assets, wages, and bank accounts from taxpayers with liens by filing a Notice of Intent to Levy.

How do you know if you have a federal tax lien?

The IRS will send you a letter if they determine that you owe taxes and have failed to pay. This is called a Notice and Demand for Payment, which outlines how much you owe the federal government.

If your federal tax debt is not paid within 10 days of the notice, the federal government can file a lien against your assets.

Federal tax liens used to show up on credit reports, but including these stopped for most reporting agencies in 2018. So pulling your credit score and report may not show if the government has put a lien on your assets. However, it is a public record and will appear in title searches and other lender due diligence checks when applying for a line of credit.

One step is to call the IRS directly at 800-913-6050 and speak to the IRS Centralized Lien Unit. Another option is to search the lien filings on your secretary of state’s website. A few companies also operate legal databases that can search for a property lien for a fee.

How do you know if you have a local tax lien?

Local governments also have the authority to file liens against taxpayers with delinquent taxes. Your local government should send a notification letter if you owe them money and may be required to make a public notice.

Contact your local county clerk or assessor’s office to find out if they have any liens filed against you or your property. You can try searching your lien filings with your Secretary of State, but each state’s process is different. Not all counties may have reported a lien to the state database.

What are some steps that taxpayers can take to avoid a tax lien?

Be proactive and stay on top of your tax obligations to avoid the hassle of dealing with a tax lien. Ensure you always file tax returns, even if you cannot pay the total amount due at the time.

Let’s say you are in financial trouble. Rather than avoid the Notice of Federal Tax Lien, try to come to an agreement with the Internal Revenue Service. At the end of the day, the IRS just wants what it is owed. Working with you is less expensive than the tax lien and levy process.

One option is to set up a payment plan agreement to repay the debt in installments over time. The government will deduct a set amount each month until the debt is satisfied, like a regular auto payment or automatic utility withdrawal.

Another option is to discharge specific properties from the lien. This option isn’t available to everyone or for all properties, so you’ll want to read IRS Publication 783 to see what qualifies.

If the tax lien prevents you from obtaining another loan, you can request subordination. It doesn’t erase your tax obligation, but it makes applying for another line of credit easier because it puts other creditors ahead of the IRS’ claim.

Finally, the Withdrawal of Notice keeps you liable for the debt but removes the public notice of the lien and stops the IRS from competing with other debtors for the property.

Generally, these are approved if your tax liability has been met and you’ve stayed in compliance for the last three years or if you’ve agreed to a Direct Debit installment plan and owe less than $25,000. There are some other stipulations you can learn about on IRS Form 12277.

What if you already have a tax lien?

If you already have a tax lien, there are a few options you can pursue to get rid of it. You can pay the total amount of taxes due, negotiate an Offer in Compromise with the IRS, or request the discharge of your federal tax lien.

Once your debt to the IRS is paid in full, the IRS will file a lien release within 30 days.

If you continue to ignore the IRS Notice of Intent, eventually, the government could initiate a Federal Tax Levy. Now the IRS is entitled to garnish your wages, any savings in your bank accounts, or any assets you have to repay the debt.

Does filing bankruptcy erase the tax lien?

No, filing for bankruptcy does not erase a federal tax lien. The federal tax lien is still enforceable and will remain in place.

Tax liens and real estate

Understanding federal tax liens is important for all taxpayers. The federal government takes delinquent taxes seriously, and the IRS has broad authority to impose federal tax liens against a taxpayer’s property.

As previously mentioned, in some states, the local taxing authorities can issue tax certificates sold at auction to private investors. A tax certificate entitles the owner to collect on the tax monies owed with interest.

If you’re interested in tax sales investing, first learn about the procedures with the local taxing authorities, as it will vary across states and counties. Certificates can be bid on in an auction, but some use a “lowest interest rate” system. In contrast, others give the certificate to the highest cash amount paid.

In exchange for winning the certificate, the investor pays the entire tax debt, interest, and penalties. Now it’s a waiting game. The property owner has a defined period (typically 1-3 years) to pay off their entire tax liability and interest.

Sometimes the homeowners do pay off their tax lien in the timeframe. But when they don’t, the tax certificate holder is responsible for starting foreclosure proceedings. Eventually, this allows the certificate owner to assume property ownership.

Real estate investors get involved in tax certificate sales because it could have a high rate of return. By being patient and betting the homeowner doesn’t pay their tax liability, the investor could end up with a real estate holding at a fraction of the cost.

The downside is that the homeowner could pay off the debt in time or may not maintain the property. That could leave the investor with a home where the renovation costs exceed the home’s value. Another possibility is that the house could have other liens, complicating foreclosure proceedings.

Understanding tax liens

You’re working to grow your wealth by choosing to own real estate. Buying a tax lien property is one method to invest in real estate. Still, it requires due diligence and knowledge in the process. Be sure to research the laws in your area and understand the risks involved before investing. We hope this helped clarify a federal tax lien and how it could affect you. However, if you want an easier way to get started in real estate investing, head over to our properties page and sign up for an account to get started today.