Given the current economic climate, short sales are becoming increasingly popular as a way to help homeowners avoid a foreclosure. Through a short sale, a borrower can sell a property for less than what’s owed on the property’s mortgage.
A short sale is an attractive solution for borrowers and creditors alike, as it is typically less expensive than a foreclosure, which often has costs associated with legal fees and the rapid decrease in the value of abandoned or generally neglected property. While a short sale can be a good option, homeowners and real estate attorneys may not know how to approach the transaction when the property is encumbered by a federal tax lien.
A federal tax lien is routinely filed by the Internal Revenue Service so that the IRS can secure payment of tax debt and gain interest in a taxpayer’s property (as well as later acquired property). Most commonly, a federal tax lien remains in effect until the tax deficiency is paid in full, successfully settled through an offer in compromise, or just ceases to be enforceable because of the expiration of the statute of limitations.
Though the federal tax lien is not permanent, there are many struggling taxpayers who are in desperate need of lien relief and cannot afford to pay the tax deficiency or wait for the collection statute to expire. For example, many homeowners with little or negative equity in their property would like to short sell their property or be approved for utilizing a deed in lieu of foreclosure.
However, they are rightly concerned about the effects of a lien. For taxpayers like these, there are viable options for relief involving the discharge of property from the federal tax lien. As representatives for their clients, real estate attorneys should be familiar with the process of discharging property from a federal tax lien.
In order to discharge property from a federal tax lien, the IRS requires a taxpayer or representative to complete Form 14135 “Application for Certificate of Discharge of Property from Tax Lien.” When completing this form, attorneys should inform clients that the discharge only applies to the property being sold, and the lien remains in effect for other assets. Also, if there is some equity in the property, but not enough to satisfy the tax deficiency, the IRS will be entitled to the remaining proceeds, minus the encumbrances senior to the IRS lien and other settlement costs in exchange for the discharge of the property.
Taxpayers who have some equity in their property to partially satisfy their tax deficiencies are eligible to complete Form 14135, under IRC Section 6235(b)(2)(A). Under this section, the IRS will consider the amount the property is selling for, the liens that have priority over the federal tax lien, and the proposed settlement costs to determine their actual interest in the property.
In order to make this determination, the IRS will request several documents from the taxpayer, discussed in detail below. As long as the taxpayer pays the remaining proceeds minus the liens senior to the federal tax lien and proposed settlement costs, the IRS will grant the discharge of the property under 6325(b)(2)(A). Subsequently, the taxpayer’s underlying tax deficiency will be reduced by the amount of the sale proceeds paid to the IRS.
Taxpayers with no equity in their property are eligible to complete Form 14135, under IRC Section 6325(b)(2)(B). Under this section, the government’s interest in the property is valueless. When determining if the government interest is valueless, the government considers both the actual value of the property and other liens, which have priority over the federal tax lien created by the government. Thus, the IRS will determine that the government has zero interest in the property when 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.
To successfully apply for a discharge of property from the federal tax lien, taxpayers must provide detailed information on the sale of their property and submit several documents. First, the application form requests the name and contact information of the lender or finance company that will be used at settlement. The taxpayer will also be expected to provide the proposed sale price of the property and should write “not applicable” within the box requesting the amount of the proceeds expected to be paid to the United States, if applying under IRC Section 6325(b)(2)(B). Additionally, the IRS requires the taxpayer to submit a proposed escrow agreement showing that this will eventually be a valid contractual transaction.
Under Section 8 of Form 14135, the taxpayer is required to provide a detailed description of his property. The taxpayer should list the physical address of the real property and provide a legible copy of the deed. The next section asks the taxpayer to provide information on the value of the property. This includes furnishing at least one written appraisal by an impartial professional appropriately qualified to appraise property, as well as one additional valuation, which can include the county valuation of the property, another appraisal by an impartial party or information on the proposed sales price for property being sold at an auction. If a taxpayer is selling his property at an auction, the taxpayer will also be expected to provide the proposed date and place of the sale, as well as a statement that the United States will be paid in the proper priority from the proceeds of the sale.
For Sections 10-14 of Form 14135, the taxpayer should list and provide a variety of important information. For example, the taxpayer should attach a copy of all the encumbrances (mortgages, judgments, etc.), which have priority over the federal tax lien, a preliminary title report, and a proposed HUD-1 statement showing all expenses associated with the potential sale or transfer of the property. The taxpayer should also explain how and when he will be divested of all interests in the property. For this requirement, the taxpayer should attach a proposed contract for the sale of the real estate.
Finally, the application form with the accompanying documentation should be sent to the appropriate address listed in Publication 4235 “Collection Advisory Group Addresses,” and submitted at least 45 days before the proposed transaction date. The advisory group manager will make a determination as to whether the application should be approved. For taxpayers applying under IRC 6325(b)(2)(A), a payment is required for the discharge of the property from the federal tax lien. However, these taxpayers should not submit the payment with the application, as they will be notified later by the advisory group manager of the specific amount equivalent to the government’s interest in the property.
If the taxpayer’s application is approved, he or she will be notified through a conditional commitment letter. The certificate of discharge will be received by the taxpayer after the IRS has received a copy of the final settlement statement and proof that the taxpayer has been divested of the title, together with a payment from the taxpayer who applied under IRC 6325(b)(2)(A).
Given the possibility that a client’s property may be encumbered by a federal tax lien, it is imperative that real estate attorneys either be familiar with the above options offered by the IRS, or advise the client to retain the services of a tax attorney or CPA firm that specializes in IRS representation. By properly completing Form 14135 and submitting the appropriate documentation on behalf of the taxpayer, an attorney can assure a client that the IRS will discharge the property from a tax lien, allowing the client to sell his or her property.
This article first appeared in the New Jersey Law Journal, a Legal affiliate. •