by Tony Mankus, Esq.
What do you do when a client wants to sell his house and you discover there is a federal tax lien of record against him at the county recorder's office?
TAX PAID
The first thing is to verify with your client and, more importantly, with the Internal Revenue Service, is whether the tax is still owed. If the tax has been paid in full, or is no longer due by virtue of abatement or expiration of the collection statute, then you ask IRS to issue a Certificate of Release. The request for a certificate of release can be made to an employee of the IRS who is actively working the case or directly to the lien section of the Special Procedures Staff. The procedure is spelled out in several sections of the Internal Revenue Manual, including §535(12), et seq, and, more specifically, in §5717.31. Also Publication 1450, Request for Release of Federal Tax Lien, describes the condition under which a Certificate of Release may be issued and the required contents of the request.
The Certificate of Release may be mailed either directly to the recorder's office, or to you, if you have a power of attorney from the taxpayer. If you're in a hurry, you can arrange to pick it up personally and hand-carry it to the recorder's office.
The Internal Revenue Service has 30 days to issue the Certificate of Release following your written request. Section 6240 of Taxpayer Bill of Rights (now incorporated into IRC §7432), provides for jurisdiction to sue the Federal Government if the IRS knowingly or negligently fails to release a lien.
TAX DUE – SUFFICIENT EQUITY
If the tax has not been paid, however, then you need to determine if there is sufficient equity in the property to pay off the IRS in full. To make that determination you must compute the balances due on all encumbrances that are ahead of the Federal tax lien and add on the expenses of the sale.
If there is sufficient equity left in the property after all prior encumbrances and sale expenses have been taken into account, arrangements can be made with the Internal Revenue Service for release of its tax lien(s) as discussed above.
For immediate release, it is important to remember that the Internal Revenue Service must be paid by a certified or cashier's check. If a revenue officer is actively working the case, sometimes arrangements can be made for the revenue officer to come to the closing with the releases. It should also be noted that one certificate of release should be issued for every recorded lien.
TAX DUE – INSUFFICIENT EQUITY
If there is insufficient equity in the property to pay off the Internal Revenue Service in full, all is not lost, however. Clear title to the property can be conveyed to the buyer nonetheless. That can be accomplished by applying for a Certificate of Discharge against the property being sold.
A Certificate of Discharge will not release the general lien against the taxpayer, but it will release the lien as to the specific property being sold. As IRM §535(12) explains,
(1) It is important to distinguish between the “release” of a Federal tax lien and the “discharge” of property from the effect of a tax lien. The release of a tax lien operates to completely extinguish the lien, while a discharge operates only to discharge specific property from the lien.
The statutory authority for issuing a Certificate of Discharge is IRC §6325(b). Section 6325(b)(1) deals with a sale of part of the property; section 6325(b)(2) deals with the sale of the entire property.
Procedures for the petition of a Certificate of Discharge are detailed in IRM §5718.2 et seq., as well as Internal Revenue Service Publication 783 and Treasury Regulation §401.6825-1(8) (Rev. Proc. 68-9).
The key factor again is determining the equity in the property. For purposes of applying for a discharge of a federal tax lien, equity is determined by establishing the balances due (till the day of closing) on all encumbrances recorded ahead of the Internal Revenue Service's lien(s). Frequently this will include the first and possibly the second mortgage, unpaid real estate taxes, (regardless of whether or not there has been a tax sale) and any judgment liens.
In addition, closing costs should be taken into account, such as loan origination fees, points, realtor's commissions, attorney's fees, fees for recordation of releases, etc.
The sale price, less the payoffs for prior encumbrances and closing costs, determines the amount the Internal Revenue Service will demand in exchange for a Certificate of Discharge. Sometimes a disagreement will arise as to what constitutes a prior encumbrance or, more likely, the amount of the closing costs. For example, while the Internal Revenue Service will frequently allow 6 to 7% realtor's commissions, it will not allow more than $750.00 in attorneys fees – regardless of the complexity of the transaction or the amount of work done by the attorney. (The Internal Revenue Service's procedures are not well documented on this specific issue and there are no relevant court decisions.)
At any rate, after the Internal Revenue Service reviews the petition, it will issue a letter of commitment, either Pattern Letter P-402 or P-403. P-402 will be issued under IRC §6325(b)(2)(B) when it is determined that there is no equity in the property (ie: Internal Revenue Service's interest in the property is valueless); P-403 will be issued under IRC §6325(b)(2)(A) when it is determined that the Internal Revenue Service's interest in the property is some specific dollar amount.
In the first case, the Internal Revenue Service promises to issue a Certificate of Discharge upon proof that the taxpayer has been divested of interest in the property; in the second case, the Internal Revenue Service promises to issue a Certificate of Release upon proof of divestiture of the taxpayer's interest as well as the receipt of the specified amount (by certified or cashier's check).
In many cases this letter of commitment is sufficient to close, though many title companies remain nervous about waiving the Internal Revenue Service's lien on the basis of the letter of commitment. Some feel that the “Internal Revenue Service is unpredictable”.
CLOSING COMMENTS
A number of interesting variations and/or permutations can develop from this basic scenario. For example it may be that the husband alone has a federal tax lien filed against him while the property is held jointly by husband and wife. In that case the Internal Revenue Service's equity, if any, is cut in half.
Other interesting variations can include foreclosure proceedings, bankruptcy and tax sales. In some cases, subordination of a tax lien or a certificate of non-attachment may be in order. All of those, however, are the stuff of which future articles are made of.
Incidentally, the procedures outlined here apply equally to real and personal property, such as machinery and equipment, as well as individuals and businesses. In the case of a sale of a manufacturer's machinery and equipment, Article 6 of the UCC (bulk sale provision) may apply as well.
© Tony Mankus, Mankus & Marchan, Ltd.