CLEANING UP THE RECORD – RESOLVING FEDERAL TAX LIENS

Russell J. Haynes, Attorney at Law

Resolving Tax Liens

It is the day before closing on the purchase of your dream home. The financing is arranged, the papers are being prepared, the money has been wired to escrow. The phone rings. It is your agent.  The title search reveals a tax lien on the house. Everyone freaks out – you, the title company, the seller, the agents, and your bank. So you do what everyone does – you go to the internet, where you find endless horror stories, and read things like “you can’t sell a house that has a lien on it,” or “if you buy a house with a tax lien on it, the IRS will take the house from you.” Hopefully, your search has brought you here so we can clarify all this for you.

We are all familiar with the concept of a “lien.” Nearly everyone has at least one lien encumbering their house, but it is usually just the one for the mortgage lender. The lien is a device used by a creditor to secure the lender’s position with regard to a piece of real property. Simply, it is a paper, filed in the land records, that turns up when someone runs a search on the property. The lien serves to put others on notice of the lien holder’s interest, i.e. the existence of the debt owed to the lien holder. Tax liens work in a similar manner. (For more information on the federal tax lien in particular, please see the in-depth articles on the subject by Burton J. Haynes.

So how does the seller get rid of the IRS lien? The first and most common method is to pay the IRS at closing. People sell property encumbered by liens all the time. Most houses being sold have one or perhaps two mortgages encumbering them. When those mortgages are paid at closing, the liens in favor of the mortgage holders are extinguished, and the property can be conveyed free and clear of the liens. Federal tax liens work in much the same way. The seller or title attorney requests a payoff letter from the IRS, just as they would get from any other lien holder.

The IRS sends the payoff letter with instructions on how much to remit and where to send it. If the IRS receives the amount listed in the letter by the stated date, the tax lien is released and a “Certificate of Release” issued. The Certificate of Release gets recorded in the land records next to the Notice
of Federal Tax Lien to provide proof that the lien was satisfied . . . and that you as the buyer get clear title, free of the seller’s tax lien.

Things gets trickier when the seller is due to receive an amount at closing that won’t be enough to pay the IRS lien in full. Don’t despair. The house can still be sold, but you as the buyer will need assurance that the IRS lien no longer encumbers the house. Without proof that somehow the tax lien has been taken off the house, the online horror stories could come true! The lien could remain attached to the house, and you and you new house could wind up in the crosshairs of IRS collection efforts.

1 Russell Haynes is an attorney in Burke, Virginia (phone 703-913-7500). Since 2011, he has been in the private practice of law, representing businesses and individuals with difficult tax issues. His practice focuses on civil
tax disputes, often involving businesses with unpaid employment taxes or returns, including worker classification issues, Trust Fund Recovery Penalties and individual exposure to withholding and other business taxes, taxcollection matters, and the tax aspects of bankruptcy. He is a frequent lecturer to legal and accounting groups on these matters.

2. See the articles by Burton J. Haynes on Federal Tax Liens, Part 1 and Part2

3 See IRS Pub. 4235 for the current contact information for the IRS Centralized Lien Operation. Follow the instructions for “getting a lien release or lien payoff balance.”

Luckily, there is a common procedure available to fix this: an Application for Certificate of Discharge.4 A Certificate of Discharge is similar to a Certificate of Release. They are both pieces of paper issued by the IRS to be recorded in the land records. The Release shows that the taxes listed on the lien were paid or became otherwise unenforceable. The Discharge removes the specific property from the reach of the lien.

In other words, the lien remains in effect and continues to encumber all of the seller’s other property, but the house being sold to you is specifically carved out of the reach of that lien. The IRS is quite willing to do this because it receives the proceeds that would otherwise go to the seller at closing.

An Application for Certificate of Discharge can be prepared and filed by the seller, the buyer, or an attorney representing the either the seller or the buyer, or by the buyer’s lender (which of course wants to make sure that the new mortgage lien is the only one encumbering the house after the closing). The process usually takes about six weeks after the Application is completed, so closing is sometimes delayed. In addition, you will need help from a title company because the Application must be accompanied by several documents, including the current deed, a preliminary closing disclosure statement (formerly called a HUD-1), an appraisal, and a copy of the IRS lien. As long
as the house is being sold for at least its actual fair market value and the IRS will receive the amount otherwise due to seller, the IRS will issue a “conditional commitment letter” saying that upon receipt of the funds due to seller at closing, the Certificate of Discharge will be issued. The IRS gets its
money, and you as the buyer are protected.

There are also times when very old liens turned up in a title search run by the title company in preparing for the closing. Often, the IRS does not issue a Certificate of Release for a lien that expires.

5 In general, federal tax liens must be refiled by the IRS within 10 years and 30 days of the assessment date listed on the original lien. But column (e) of the Notice of Federal Tax Lien Form 668(Y)(c), will list the “last day for refiling.” The federal tax lien has special language that makes the lien “self-releasing.” In a box halfway down the front page there appears the following language:

IMPORTANT RELEASE INFORMATION: With respect to each assessment listed below, unless notice of lien is refiled by the date given in column (e), this notice shall, on the day following such date, operate as a certificate of release as defined in IRC 6325(a).

In other words, the lien itself is the equivalent of a Certificate of Release if the IRS does not refile the lien by the date listed in column (e). That is typically sufficient proof for the lender and the title insurance underwriter that the expired tax lien no longer encumbers the property. If necessary, the
IRS can be asked to issue a separate Certificate of Release even for a lien that has expired. But, it can add several weeks to the process. Accordingly, encouraging the title search to be run as early as possible can sometimes be quite helpful.
4 See IRS Pub. 783 for instructions on how to how to complete Form 14135 and submit it to the IRS.

5 For more on the expiration of federal tax debts, see our article on the Statute of Limitations.