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Real Estate Investing Loophole: Tax Lien Investing with a Self-Directed Checkbook IRA

September 4, 2024

Written By: Dana Udumulla

Key Points 

  • A tax lien is a legal claim placed on a property when the owner fails to pay property taxes.
  • Tax lien investing with a Self-Directed Checkbook IRA is an indirect approach to investing in real estate.
  • Madison Trust makes self-directed tax lien investing seamless, with a straightforward process and a dedicated support team.
Miniature model of a house, calculator, coins, and papers on a desk to signify investing in a tax lien with a Self-Directed IRA.

Real estate is one of the most popular investments for savvy investors looking to earn passive income through alternative investing. Those seeking to diversify their portfolio and potentially grow their investment income in a tax-advantaged account can utilize a Self-Directed IRA (SDIRA). One often overlooked way to invest in real estate is through a tax lien with Checkbook Control. Rather than buying a property, the investor buys a tax lien certificate and collects interest on the unpaid taxes.

In this blog we’ll explore what a tax lien is, benefits of investing in a tax lien, how investing in a tax lien with a Self-Directed Checkbook IRA works, and potential considerations.

What Is a Tax Lien?

Miniature model of a house next to a percentage sign with a Self-Directed IRA investor in the background signing papers to invest in a tax lien.

A tax lien is a legal claim placed on a property when the owner fails to pay property taxes. Local governments, typically the city or county where the property is located, use this to collect unpaid property taxes from the property owner. A tax lien can be issued on almost any types of property, such as raw land, residential real estate, and commercial property

How Self-Directed Tax Lien Investing Works

If a property owner cannot pay their taxes, the government puts a tax lien on the property. The local government then typically issues a tax lien certificate detailing how much they owe, including interest and possible penalties. The certificate is generally then auctioned to investors if the taxes remain unpaid. This is where self-directed investors come in, since SDIRAs allow for the investment in alternative assets with Checkbook Control, including promissory notes, precious metals, real estate, and tax liens.

Self-directed investors can bid on the tax lien certificate. The winning bidder takes ownership of the tax lien certificate, not ownership of the property. The tax lien certificate gives investors the right to collect when a homeowner repays their overdue tax bill.  

As the investor, you are immediately responsible for paying the tax bill including interest and fees. Investors typically must enforce the certificate within a certain timeframe to collect what is owed. If the homeowner fails to pay what they owe within a specified redemption period, the investor can take ownership of the property through foreclosure. However, most homeowners pay their tax bills before the foreclosure process begins. 

Miniature model of an investment property with a “Sold” sign, house keys, and judge’s gavel on a table to indicate that you can purchase a tax lien at a public auction.

Why Invest in Tax Liens? Benefits of Investing in Tax Liens

  • Investing in tax liens can potentially earn you high interest rates, varying by state and locality, typically ranging from 12-36%. This can lead to substantial returns to your Self-Directed IRA with Checkbook Control.
  • If the property owner does not pay back their taxes in time, the investor can become the property owner through foreclosure. The investor can then decide whether to sell the property or keep it to earn rental income.
  • Tax liens allow for the investment in real estate without directly owning a property, diversifying your investment portfolio. 

Steps to Invest in a Tax Lien with a Self-Directed Checkbook IRA

Tax Liens vs. Tax Deeds: What's the Difference?

Self-Directed IRA investors signing papers and pointing at a miniature model of commercial real estate.

Self-Directed Checkbook IRAs also provide the opportunity to invest in a tax deed. A tax deed gives immediate ownership and title to the property to the winning bidder. This is different from a tax lien, since tax lien investors do not acquire the title to the property. Instead, they're buying the right to receive interest payments on the amount owed to the taxing authority.

Considerations for Tax Lien Investing with a Self-Directed IRA

If you are investing in tax liens with a Self-Directed IRA with Checkbook Control, it is important to understand the rules that apply to these accounts, including prohibited transactions. Here are a few important rules to keep in mind:

  • All income must flow into the Self-Directed Checkbook IRA's dedicated checking account.  
  • All expenses, including costs associated with bidding, purchasing, and managing your tax lien investment, must flow from the Checkbook IRA's checking account. 
  • You cannot purchase an investment from a disqualified person. You or a disqualified person cannot rent, live in, or work on the investment property.
  • Like making any investment, it is considered best practice to conduct thorough due diligence when investing in a tax lien. Consider researching the property’s location, current market value, and have an exit strategy in place. 
  • Consider speaking to a financial professional, tax advisor, relator and/or appraiser to assess the value of the property prior to bidding on its tax lien, and an attorney who is well-versed in the tax lien laws in the state you plan to purchase the tax lien in. 

Conclusion: Let's Tie It All Up

Tax lien investing with a Self-Directed Checkbook IRA is an indirect approach to investing in real estate. It can be a potentially lucrative and rewarding strategy for those looking to diversify their retirement portfolios and potentially achieve high returns. Similar to any investment, it requires research, due diligence, and thorough understanding of the rules involved. Take your retirement portfolio to new heights by leveraging the tax advantages of a Self-Directed IRA and the potential high interest rates of tax liens. 

Investment Sponsor standing in front of a real estate investment property smiling and holding a coffee cup.

Have Questions about Tax Lien Investing in a Self-Directed Checkbook IRA?

We have answers! Contact a Self-Directed IRA Specialist at Madison Trust today to get the answers you need about self-directed investing.


Disclaimer: All of the information contained on our website is a general discussion for informational purposes only. Madison Trust Company does not provide legal, tax or investment advice. Nothing of the foregoing, or of any other written, electronic, or oral statement or communication by Madison Trust Company or its representatives, is intended to be, or may be relayed as, legal, tax, investment advice, statements, opinions, or predictions. Prior to making any investment decisions, please consult with the appropriate legal, tax, and investment professionals for advice.

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