Can You Use a Self-Directed IRA to Invest in Tax Liens?

When you have a self-directed IRA as part of your retirement strategy, you’ll have a much wider range of investment options available for your nest egg. With a custodian such as Quest Trust Company, you’ll be able to invest in precious metals, private equity, and real estate. Individuals who first become interested in opening a new self-directed IRA often get that interest because they think they might be interested in making real estate with their retirement funds.

But direct investments in property are only one way to invest in real estate related items. You can use a self-directed IRA to make private mortgage loans secured by real estate, and you can invest in tax liens as well.

What are “Tax Liens”?

A tax lien is essentially an encumbrance worked at that place on certain property (usually real estate) when the owner of that property fails to pay their taxes. There are several important legal implications of tax claims. For the property owner, the most important implication is that if they fail to make good on their tax debt, then the taxing authority (generally a local government) will eventually have the legal right to foreclose and force a sale of the property in order to

Local governments do this out of necessity. Simply put, they need the cash immediately, in order to fund operations, and can’t afford to wait for the taxpayer to make good on their property tax obligation. In order to obtain their funds, the local government will sell the right to receive those tax revenues to a private investor. The investor receives the legal right to receive payment of the tax from the delinquent property owner, plus interest that occurs at a predetermined rate.

Investing in Tax Liens With a Self-Directed IRA

Tax liens are essentially a debt instrument secured by a piece of property. As such, they are a permissible investment class for a self-directed IRA.

However, unlike many investment types that you may be familiar with, the actual process for making investments in tax liens varies from local government to local government. One common approach is for the local government to auction off each lien individually, with the beginning at the face value of the debt owed. In most tax lien auction scenarios with more than a few properties up for bid, there will be a range of premiums that are bid.

The Right to Receive Property

The biggest source of confusion surrounding investments in tax liens is the right of the tax lien investor to take possession of the underlying property in order to receive payment. While it’s generally true that after a certain period of nonpayment the holder of the tax lien can foreclose upon the property, this procedure is not available quickly, and there are usually multiple opportunities for the taxpayer to redeem their property interest.

The bottom line is that tax liens may be a suitable investment for your self-directed IRA, but you should not make those investments in anticipation of taking title to real estate at a deep discount.