More On Lien Releases

Originally published on Passive Activities and Other Oxymorons on December 4, 2010.

IRSIG SBSE-05-1010-054


My Monday post on PMTA 2010-058 seems to have been my first scoop. It concerns the IRS position on aspects of releasing liens to facilitate short sales. The idea is that a lien on a property with a first mortgage far in excess of value is worthless and should be released. The IRS was taking the position, though, that they were superior to carve-outs for transfer taxes. This creates a Catch-22 that would prevent the short sale unless the taxpayer/owner could come up with the transfer taxes. The statement (PMTA stands for Program Manager Technical Assistance) retreats from that position and recognizes that the transfer taxes are really coming out of the first lienholder. It also mentioned homeowners associations dues as something that the first lienholder might decide to allow to be cleared.

All week long nobody else seems to have picked up on this. I found an attorney in Florida who has a blog dedicated to short sales, who wrote me that he had been in "shouting matches" on this very issue. He wrote a post on it, crediting me with the discovery. I also found that there is a lot of misinformation out there on this issue with many in the blogosphere believing that the IRS has a super priority that can never be released. Really astounding when you consider how reliable random websites and blogs are on most other issues. (My son tells me that irony doesn't come across well in text. What do you think ?)

I also found that subsequent to the PMTA there is another IRS document which I am reproducing in full since it is pretty crisp:

IRSIG SBSE-05-1010-054
Certificates of Discharge in Short Sale Situations
October 4, 2010
Control Number: SBSE-05-1010-054
Expiration Date: October 5, 2011
Impacted : IRM 5.12.3

MEMORANDUM FOR DIRECTORS, COLLECTION AREA OPERATIONS DIRECTOR, ADVISORY, INSOLVENCY, AND QUALITY

FROM:

Frederick W. Schindler /s/ Frederick W. Schindler Director,
Collection Policy
SUBJECT:
Certificates of Discharge in Short Sale Situations

The purpose of this memorandum is to issue interim guidance for processing and approving requests for certificates of discharge in short sale situations. The impacted section of IRM 5.12.3 , Certificates Relating to Liens, will be revised to include the information in this memorandum. Please ensure that this information is distributed to all affected employees in your organization.

The authority of the Internal Revenue Service (IRS) to issue a certificate of discharge of property subject to the federal tax lien is found in Internal Revenue Code (IRC) section 6325(b). Among other conditions, the IRS may issue a certificate of discharge when the interest of the United States in the such property is determined to have no value ( section 6325(b)(2)(B)).

A short sale occurs when the senior lien holder agrees to accept less than the total amount owed as satisfaction for its lien claim. For example, a bank has a priority mortgage claim for $600,000, but, due to the significant decline in the real property market, the bank agrees to a sale of the mortgaged property for $300,000. Because the senior lien attaches to all the equity in the property, generally the lien interest of the United States in short sale properties is valueless. Therefore, applications for discharge for properties subject to short sales should be considered under IRC 6325(b)(2)(B).

To facilitate the sale of the property in these situations, the senior lien holder might negotiate the payment of expenses to be taken from its settlement amount. In certain situations, these expenses might be greater than normal closing costs allowed by the IRS and might include creditors that would otherwise be junior to Certificates of Discharge in Short Sales the IRS. This action by the senior lien holder to carve proceeds out of its priority claim to pay these expenses does not create an equity interest on the part of the taxpayer which may be reached by the IRS lien. Provided there is no fraudulent aspect to the payment distribution and the lien interests of the IRS in other properties of the taxpayer is not being harmed, the IRS has no authority to require payment of the sum that otherwise would have gone to the senior lien holder.

Following the previous example, the bank determines that out of the $300,000 sales price, it will allow $15,000 of expenses to be paid. Most of the $15,000 is for normal closing costs, but $5,000 of it is for a homeowner's association fee, which is junior in priority to the IRS, and $2,000 is for state transfer taxes. Because the payments made for the homeowner's association fee and the state transfer taxes are made from proceeds attributable to the bank's priority lien interest and the interest of the IRS in the property to be discharged is valueless, the IRS cannot condition discharge upon payment of any part of the amount going to these expenses.

Therefore, upon receiving an application for discharge of a property subject to a short sale, follow standard procedures outlined in IRM 5.12.3 to investigate the statements made in the application regarding the transfer, encumbrances on the property, property values, and proposed distribution of the proceeds. Additional documentation to complete the investigation may be requested if the information has not otherwise been provided. Presuming no issues are identified, the discharge application can be approved following existing IRM procedures.

In normal (non-short) sale situations, where the lien claim of the bank is fully paid and the federal tax lien attaches to surplus proceeds, the IRS's lien interest must be satisfied in accordance with IRC 6325(b) before the property can be discharged from the lien. Creditors junior to the IRS interest are not entitled to payment from the proceeds before the IRS lien interest is fully paid.

If you have any questions, please contact me, or a member of your staff may contact Kyle Romick, Senior Program Analyst.

I have to admit that I don't know what IRSIG stands for. SBSE is small business self employment. This would be more embarrassing except for the fact that IRS employees testifying in Tax Court on internal documents that have been put in evidence sometimes can't explain what their codes mean.