Investing in Tax Liens and Deeds with Retirement Funds

Many people know that real estate is a preferred asset in a self-directed IRA. It’s the number one investment clients of Advanta IRA choose to use to build wealth in their plans. Anything from commercial and residential property to rehabs and rentals to farm and timberland falls within the real estate-investing realm.

A few other real estate-related investments we see are in tax liens and deeds. Acquiring these assets self directed IRA tax lien and tax deed investing is a fairly common technique that many people use to earn income. In the case of using retirement funds, your self-directed IRA would make the purchase and earn tax-sheltered income on the interest due on the lien, or by reselling the property attached to a land deed.

Here’s how it works

The municipalities in which the property is located are able to sell tax liens and deeds for homes that are in arrears on these taxes. Why do they do this? Because cities and counties depend on the income these taxes generate. They are able to recoup this on a timely basis when investors purchase the liens and deeds for property whose owners have fallen behind on these payments.

After a certain period of time when taxes are in arrears, the municipality can auction off the liens and deeds to the highest bidder. Investors purchase them at an amount that includes late fees, taxes, and interest due at the time of sale. If you use your self-directed retirement plan to make these purchases, your IRA would be listed as the owner of the certificate and earn tax-sheltered income on any gains the investment produces.

In the case of tax liens, the purchaser owns the note and is responsible for collecting payment from the property owner. New interest rates are set—and can be higher than the governing entity would charge—and the investor makes income as the note is repaid. The average term of the new lien is usually set between one and three years. If the property owner defaults, the note-holder can take possession (adding another opportunity to earn income through resale).

Tax deeds operate in much the same manner, except in these transactions the deed to the property is sold, giving the buyer ownership of the property. Investors have the opportunity to rehab-and-flip homes for a quick profit or they can use the property to gain consistent income over time on rental payments.

Bear in mind that while purchasing tax liens and deeds can be relatively cheap, all things considered, if you haven’t done your due diligence it can be quite costly, too. Investors must ensure there are not additional liens on the properties (like a huge mortgage, or a lien placed by a contractor that was never satisfied). Proper steps must be taken to have these liens removed or investors could find themselves in quite a financial pickle when they purchase the liens or deeds associated with the property. You also want to investigate the area the property is located—if there’s not much chance for resale to earn a profit, you may want to reconsider investing in that particular parcel.

Also, when investing in tax liens and deeds with retirement funds, understand that just as all income flows directly into that account, all expenses must be paid with funds from the account. So, if you purchase a deed or find yourself in a situation where the payee of the tax lien defaults and your IRA takes ownership of the property, be sure your IRA or other self-directed plan has enough capital in it to cover any costs for maintenance or renovations.

If you’ve properly vetted your investment and all the particulars involved, you have the potential to earn income like many others do by investing in these alternative options.