Selling Your Real Property with an Attaching Federal Tax Lien

Investing
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By Michael Rude

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Many people, including experienced real estate agents, escrow officers and other tax professionals, do not understand that real property with a federal tax lien balance that exceeds the equity in the property can be sold without paying the federal tax lien in full. The process involves obtaining a certificate of discharge from a federal tax lien.

Basis for Discharge

Discharge of property from the federal tax lien may be granted under several Internal Revenue Code (IRC) provisions. While there are five Internal Revenue Code sections that may apply to various situations where a federal tax lien attaches real property, almost all discharge applications are submitted under the following two code sections.

IRC § 6325(b)(2)(A). A discharge may be issued under this provision when the tax liability is partially satisfied with an amount paid that is not less than the value of the U.S. government’s interest in the property being discharged.

For exam­ple, the IRS has a lien totaling $210,000 with the following circumstances:

  • Property selling for: $215,000
  • Minus first mortgage payoff (senior to IRS lien): $135,000
  • Minus acceptable settlement costs: $15,000
  • The IRS lien interest equals: $65,000
  • After the IRS receives and applies the $65,000 in partial satisfaction of the tax liability, there remains an outstanding tax debt of $145,000.

The federal tax lien remains in place in the amount of $145,000 against any other remaining assets of the taxpayer but the property is sold free of the federal tax lien by virtue of the U.S. government receiving its $65,000 equitable interest.

Note: In the case of Tenancy by Entireties property, the U.S. is generally paid one-half of the proceeds in partial satisfaction of the liability secured by the tax lien.

IRC § 6325(b) (2) (B). A discharge may be issued under this provision when it is determined that the government’s interest in the property has no value. The debts senior to the federal tax lien are greater than the fair market value of the property or greater than the sale value of the property.

For exam­ple, the IRS has a lien totaling $100,000 with the following circumstances:

  • Property selling for: $190,000
  • Minus first mortgage payoff (senior to IRS lien): $175,000
  • Minus acceptable settlement costs: $15,000
  • The IRS lien interest equals: $0

In this scenario, upon submission of a properly prepared application for discharge and approval, the IRS would discharge the federal tax lien for $0 as there is no equitable interest. The lien remains in place against any other assets of the taxpayer.

I highly recommend enlisting the services of a tax professional when trying to sell your property with an attaching federal tax lien unless there is sufficient equity to pay the lien in full. The two scenarios stated above have been simplified for illustration purposes. Tax professionals with experience in the areas of “discharge” and “subordination” applications can navigate the complexities of each individual situation.

In addition, there are situations when a federal tax lien attaches the property of a third party. An application for discharge may apply in these situations. Estate tax liens may also be discharged under certain circumstances. Both of these situations require the help of an experienced tax professional.

Note: There are circumstances where an application for certificate of discharge of a federal tax lien may be needed when selling personal property but this article is specific to real property. Consult a tax professional if you have questions regarding applications for discharge or subordination.