Even More About Short Sales

Originally published on Passive Activities and Other Oxymorons on February 20th, 2011.
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I received a very gratifying email yesterday :

We are happily settled in our new home. Thank you for all your help.

The lady who sent it had been trying to purchase a home on a short sale where the seller was receiving a relocation grant.  The seller had an outstanding IRS lien.  The collection agent responsible for releasing the lien finally gave in after she sent him a copy of CCA 201102058 which she had learned about from my blog post.  What is really intriguing is this particular development seems not to have attracted any notice to speak of.  Check out this search.  It seems like, except for one broken link, I'm the only one who has written on this.

My friend, Stephen McWilliam, a Florida realtor has suggested to me that this may be because the HAFA relocation money is not really flowing yet, making the problem more of a theoretical one. Stephen is a really smart guy.  I have a pretty good aptitude for what I do and I have experience and focus.  It's always a little humbling to realize that other people I meet in business and am able to help would probably be better at what I do than I am.  Fortunately they chose other fields.  I think in economics this is referred to as "comparative advantage".  At any rate, Stephen mentioned something about the tax aspects of short sales that had never occurred to me.  Presumably when you are behind on your mortgage you owe both interest and principal.  When the short sale goes through for some transitory moment the money is yours even though your don't get to touch it.  If the bank applies the proceeds to interest, you should potentially be able to deduct that interest and should be looking for a Form 1098.  I usually try to tie my posts to specific pronouncements, but I haven't been able to find anything that addresses this head on.

This is separate from the issue of getting a Form 1099-C which may require you to recognize income on a short sale.

Another Scoop for PAOO - Short Sale Relocation Assistance Does Not Create Lien Equity

Originally published on Passive Activities and Other Oxymorons on January 24th, 2011.
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CCA 201103045


So here is another bonus post.  Last week I did a post on CCA 201102058.  It concerns relocation grants under the HAFA program.  As I understand the program a senior lien holder can pay an upside down property owner up to $3,000 in relocation assistance to facilitate a short sale.  The CCA indicated that the IRS cannot require that this money be turned over to them as a condition of releasing their otherwise worthless lien.

CCA 201103045, which I reproduce in full below explains that the position on relocation assistance is similar to the position that was first enunciated in PMTA 2010-058.  In that statement they discussed carve outs for transfer taxes, which also do not create equity.
Over the weekend I received an e-mail from someone whose short sale was being hung up because of this issue.  I have yet to see any other commentary on it.

ID: CCA_2010121214444350
Release Date: 1/21/2011 Office: —————
UILC: 6325.00-00 



From: ———————————- Sent: Sunday, December 12, 2010 2:44:46 PM To: ———————————- Cc: ———————————- Subject: RE: opinion

It's not really the same situation although the result is the same - i.e., they should not include the payment in computing the Service's interest in the property. The October IG [interim guidance] memo deals with carve-outs to junior lienholders from money that would otherwise go to the senior lienholders. The relocation assistance is not part of the sale proceeds, it's just a payment made directly to the taxpayer and, as such, is not part of the taxpayer's interest in the real property to be discharged from the lien. A new IG memo on this will be coming out soon.

If you have a short sale that is being hung, you may have to wait for the "new IG memo" to percolate through collection, but it might be worth referring to the Chief Counsel Advice.  If this ends up being helpful, I'd appreciate you posting a comment on this blog.

More On Short Sales- Relocation Grants are For Relocation

Originally published on Passive Activities and Other Oxymorons on January 18th, 2011.
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CCA 201102058


Last month I wrote a post about IRS allowing that a carve-out by a lender for transfer taxes does not create equity in their lien.  That burst of generosity is followed this month by even more beneficence.  If under the Home Affordable Foreclosure Alternative program, the senior lender provides a taxpayer with $3,000 in relocation assistance, they can actually use that money to pay relocation expenses.  The full text of the ruling is below:


In consultation with the Collection experts in Counsel, below is the answer to your question concerning whether the IRS can require a taxpayer to pay the IRS the amount of relocation expenses as a condition of discharge. Recently, the Treasury Department introduced the Home Affordable Foreclosure Alternatives (HAFA) program. The HAFA program took effect on April 5, 2010. Borrowers who participate in a HAFA transaction are eligible for $3,000 in relocation assistance. If the senior lender provides the taxpayer with the $3,000 relocation assistance required under the HAFA program, the IRS cannot require the taxpayer to turn the $3,000 over in exchange for the lien discharge. The HAFA program payment is a payment directly made to the taxpayer to assist in relocation. As such, the relocation payment has no bearing upon the taxpayer's equity in the property under a discharge analysis. Rather, this is just a payment to the taxpayer. Furthermore, under the terms of this program, since this is a required payment as a condition of participation in the program, it would likely be treated as an ordinary expense of sale to be allowed priority despite being reached by the federal tax lien. If a lender provides relocation assistance because the lender believes it makes good business sense and not because it is required under HAFA, the legal answer is the same. The IRS cannot require the taxpayer to pay the IRS the amount of the relocation expenses as a condition of discharge.

I don't know how we are ever going to solve the deficit if the Chief Counsel keeps giving away the store like this.

Cleaning Up For the New Year - Thank You Maam

Originally published on Passive Activities and Other Oxymorons on January 3rd, 2011.
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I still have a good backlog of 2010 material, that isn't blossoming into full length posts so here are a few quickies.

CCA 201048042

I'm involved in doing a lot of partnership returns and I think we do a pretty good job.  One of the trickier parts is the liabilities section on the K-1.  From our individual practice, I get to see a lot of the K-1's that are prepared elsewhere.  Often it is pretty clear that they are wrong.  Frequently it does not matter, but sometimes it does.  A large deficit capital balance with no liability allocation is an example of a likely error. This CCA provides a little bit of a warning in deal with clearly erroneous K-1's.
Section 6222 requires the partners to report the amount and allocation of liabilities consistent with the partnership return unless they file a Notice of Inconsistent Treatment on Form 8082. In the absence of such a filing we are permitted to make an assessment without issuing a FPAA. I.R.C. 6222(c). They filed no such notice here so we do not need to conduct a TEFRA proceeding to make the assessment. Since outside basis is an affected item requiring partner-level determinations, however, we would have to issue an affected item notice of deficiency in order to assess a distribution in excess of basis. In the stat notice proceeding they could arguably rely on Roberts v. Commissioner, 94 T.C. 853, 860 (1990) to allege that the partnership books and records reflect the nonrecourse debt in issue, their reporting is consistent with the actual partnership books and records, and that the Schedule K-1 issued to them was incorrect. Cf. Treas. Reg. 301.6222(b)-3 (incorrect schedule provided to partner).

Private Letter Ruling 201048025, 12/03/2010

Code Sec. 1031(f); won't make benefits of Code Sec. 1031(a); unavailable to corp. under described circumstances provided that taxpayer, related party, and any affiliate undertaking exchange hold their respective replacement property for two years following their respective acquisition of replacement property.

This was a fairly convoluted set of facts.  It involves a sequence of related party exchanges.  I think the point of it was that since there was no ultimate cash out, nobody was getting away with anything.  I'd appreciate any comments that anybody else who has studied this ruling might have.

Lori A. Malchow-Bartlett v. Commissioner, TC Memo 2010-271

Taxpayer was denied deduction for use of home for day care, because she was not properly licensed :

Under section 280A(c)(4)(A), a taxpayer may be allowed business expense deductions relating to use of a residence to conduct child day care services. However, the deductions are allowed only where the taxpayer has obtained, or has applied for and has pending, a license to conduct child daycare services under applicable State law or is exempt from obtaining a license therefor under applicable State law. Sec. 280A(c)(4)(B).

The court concluded that taxpayer acted in good faith so no penalties were assessed.

U.S. v. BEDFORD, Cite as 106 AFTR 2d 2010-7271, 12/09/2010

This case is really outside my area of interest.  It is a criminal appeal.  The thing that got him in trouble was kind of interesting though.


The genesis of this case involved a business called Tower Executive Resources that billed itself as an executive recruitment business. In fact, Tower promoted to its members the opportunity to protect assets and to enjoy tax deferral through an offshore venture. Tower marketed its asset protection services to select clients through seminars at which Defendant and others spoke.

Essentially, clients learned at these seminars how to create bogus corporate entities called “international business corporations,” referred to as IBC-1s and IBC-2s. IBC-1s were domestic corporations that would hire and pay IBC-2s, foreign corporations, to perform services for the IBC-1s. Those services did not actually occur.

Mohamed M. Magan v. Commissioner, TC Summary Opinion 2010-173

In January 2007, petitioner moved from the State of Minnesota to the State of California in order to be closer to his sister and her family. Throughout 2007 petitioner's sister was married and lived with her husband and five children in a single- family home. Petitioner's sister was a stay-at-home mom and her husband was a full-time student who only started working in late 2007.

From January to August 2007, petitioner worked nights. Although petitioner did not live with his sister and her family during this time, he would spend much of his time at their home helping with childcare and doing the family's errands. In addition to assisting with childcare and errands, petitioner also provided his sister's family with financial assistance.

In August 2007, petitioner obtained a job located far away from where his sister and her family lived. For the remainder of 2007, petitioner was unable to help his sister with child care and errands, but he continued to provide financial assistance.

Petitioner claims that he is entitled to dependency exemption deductions for his two nieces because he provided financial assistance, as well as help with child care and the family's errands. We commend petitioner for contributing to the support of his sister's family. However, he has not demonstrated that he and his nieces shared the same principal place of abode for any portion, much less for more than one-half, of the taxable year in issue.

I thought the commendation from the Tax Court was a nice touch, even thought they couldn't help the poor guy, who seems to have deserved a break.

It looks like January will have a few more post like this as I work through my backlog.  If anything really significant develops, I'll be sure to do a bonus post.

IRS Claims Discretion In Minority Discounts In Lien Discharge Cases

CCA 201048036

There are at least two kinds of education.

I've been puzzled by the subject of my Monday post not generating more interest.  It concerns the IRS relaxing its position on releasing liens for short sales.  The most obvious possible explanation and one that has been given some credence by an e-mail I received from Richard Zaretsky who picked up on my post in his blog on short sales is that IRS liens are not a factor in all that many short sales.

The other possible explanation I have come up with, while possibly less probable, is more entertaining, so I will share it.  I have noted here and there, that tax administration and, accordingly, tax practice can be divided into two very broad areas - determination of the correct tax and collection.  Hold that thought for a moment while I tell one of my stories.

When I was starting in public accounting one of my college classmates was starting his own law practice.  He explained to me that he would do somebody's will for $50 or handle their divorce for $100 if that was all they could afford because "Then I'm their lawyer.  And anybody can get hit by a car."  He spent more time in court than most lawyers I know, because that made the insurance companies more afraid of him.  I get the impression that focusing on collections creates an accounting practice that is more analgous to his practice than that of a larger firm that commands large retainers and has some proportion of its professional staff spending more time in the library (do whatever technological updat you choose on that image) than the courthouse, if they even know where the courthouse is. I further know that there are very few people who comb through the more obscure pronouncements like CCA's and PMTA's so they can blog on them. It's conceivable that none of them have practices that focus on collection.  So maybe the whole collection wing of the industry is going to start counting on me.

Doesn't seem very probable, but just in case I'm going to be more sensitive to collection issues.
 CCA 201048036, which I have decided to reproduce almost in full is also on the subject a liens.  It holds that IRS is not required to consider minority interest discounts in lien discharge cases.

There is nothing in the Code, the regulations, or the IRM that requires the Service to apply a minority interest discount in discharge cases.In fact, there is no reference at all to the discount with regard to valuationfor lien discharge purposes. Your email does not detail the basis of the attorney's conclusion that the discount (as well as force sale value) should apply here. I assume the attorney's reasoning relates to Rev.Rul.93-12 and the use of minority interest discounts in the gift and estate tax context. However, the revenue ruling is, here, not on point factually or with respect to its conclusion. 


The regulations under section 6325 do provide some guidance regarding valuation of the government's lien interest for discharge purposes: 


Valuation of interest of United States. For purposes of paragraphs (b)(2) and (b)(4) of this section, in determining the value of the interest of the United States in the property, or any part thereof, with respect to which the certificate of discharge is to be issued, the appropriate official shall give consideration to the value of the property and the amount of all liens and encumbrances thereon having priority over the Federal tax lien. In determining the value of the property, the appropriate official may, in his discretion, give consideration to the forced sale value of the property in appropriate cases.

Treas. Reg. 301.6325-1(b)(6). IRM 5.12.3.12 similarly provides for the discretionary use of forced sale value. Note that the application of forced sale valuation is not required-its -use is determined on a case-by-case basis: I had a conversation with a lien analyst in the NO, and she indicated that a lien advisor should determine whether, in a particular case, (and to what extent) forced sale value should be used. Therefore, use force sale value is a determination for the lien advisor to make. You mentioned that the lien advisor had a conversation with a PALS. That is a good starting point. The lien analyst mentioned that there are also Collection personnel in the NO who can be a resource in addressing valuation issues. 


You did not raise, but we also note that the coowner of encumbered property can apply -for a discharge under section 6325(b)(4). That provision enables an owner (other than the taxpayer) to make a deposit (or provide a bond)in the amount determined by the Service, then seek judicial review under section 7426(a)(4).Discharge under any other provision is discretionary, andjudicial review under section 7426(a)(4) is available only for discharges issued under section 6325(b)(4).

Nothing From Nothing Is Nothing

Originally published on Passive Activities and Other Oxymorons on December 6, 2010.

CCA 201047021

This one is of somewhat limited interest and difficult to bring to any length so I'm making it a bonus post.  When someone dies their tax carryovers, capital loss carryovers for examples, die with them.  If there are assets, a new taxpayer is "born", the decedent's estate.  Estates are something of a hybrid between individuals and partnerships.  If they retain income the estate pays tax on a compressed version of the individual tax table (same rates, smaller brackets).  If income is distributed it is taxed to the beneficiaries.  Net capital losses, however, are carried forward.  Ultimately estates terminate.  When they do carryovers are flowed through to the beneficiaries.

What happens if an estate goes bankrupt and never distributes anything to anybody ?  In this particular case the decedent had substantial unpaid income tax liabilities.  A settlement was entered into whereby all assets of the estate after administrative expenses went to the United States.  The IRS position outlined in CCA 201047021 is that since the United States was the one suffering from the losses in this case, the empty handed beneficiaries don't even get a flow through of the capital losses on the estate's termination.

Section §1.642(h)-3(a) states carryovers and excess deductions pass only to “beneficiaries succeeding to the property of the estate or trust” who are “those beneficiaries upon termination of the estate or trust who bear the burden of any loss for which a carryover is allowed....” In the present case, the individual beneficiaries of the Estate should no longer be considered beneficiaries after the Estate entered into the Settlement Agreement to transfer all the proceeds of the Estate to the United States. This is a distinguishable situation from that set forth in the allocation example. Beneficiaries in that example received a loss carryover despite not receiving any property, but could have received property if the estate had sufficient funds. Here, as a legal matter, the individual beneficiaries could no longer receive anything. Any losses incurred by the Estate were to the detriment of the United States rather than the individual beneficiaries. Therefore, the Estate's beneficiaries should not be entitled to any of the Estate's unused loss carryovers under § 642(h)(1).


It  will be interesting to see whether there will be more to read about this in the future.  A CCA is not authority, so if the dollars are big enough the beneficiaries may contest it.

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.

IRS To Stop Lousing Up Short Sales

PMTA 2010-058

This was originally published on PAOO on November 29th, 2010.

For the latest on this see my follow-up post

When I was a kid, my father worked on Wall Street. He was a Senior Order Clerk. I'm not sure whether his job still exists. It was not particularly lucrative, but I got these insights into high finance through the jokes that he used to tell me. Most of them I didn't "get" until I was in my thirties. One of my favorites is the little ditty "He who sells what isn't hissen, buys it back or goes to prison." That was about short sales as the term relates to securities.

The term means something else in real estate. If a property has a fair market value lesser than the mortgage, the secured party might let the property be sold for an amount lesser than the mortgage. This avoids the need for foreclosure. The owner may or may not remain liable for the balance, the discharge of which may or may not be a taxable event. Such is not the topic of this post.

When I was buying a condo, I found that buying property on a short sale tended to be fraught with delay. You would think that the pressure to sell would create pressure to move things along, but the pressure is not sufficient to overcome bureaucratic inertia. Not surprisingly people who have trouble paying their mortgages frequently have trouble paying their taxes. So it is not unusual for a property with an upside down mortgage to have IRS liens against it. In order for the property to transfer the IRS must release its lien.

Typically the first mortgage will have been in place before the IRS filed its liens. So the value of the lien is the lesser of the tax obligation or the taxpayers equity in the property. In the case of a short sale the latter amount is 0. So the IRS should release its worthless lien and let life go on. That is not what has happened though. Even though the IRS is behind the first mortgage, they are, or at least, believe they are ahead of everybody else :

Applications for Discharge Which Include Requests for Payment of Real Estate Transfer Tax....In cases where a filed notice of federal tax lien has perfected the interest of the United States in such property, the Service is asked to issue a certificate of discharge of federal tax lien to allow payment of the state's claim at closing. It is the Service's position that such taxes have no priority status under I.R.C. §6323(b)(6) against the filed notice of federal tax lien. ... Priority of the federal tax lien is defined exclusively in I.R.C. §6323. Under no circumstances will a discharge of federal tax lien be issued for less than the full value of the Service's claim on the equity in the subject property. The transfer tax will not be accorded priority status or treated as an expense of sale. Applications that include such provisions will be rejected.

Under this interpretation, the taxpayer/property owner has to come up with the transfer taxes in order to move the transaction on.


PMTA 2010-058 finds the above interpretation to be erroneous:

We disagree with the conclusion that the designation by the senior lienholder of some of its proceeds to be used to pay real estate transfer taxes in connection with short sales of real property somehow creates an equity interest in the property on the part of the taxpayer. Rather, these are expenses that the senior lienholder agrees to carve out of its priority lien claim as a matter of business prudence in order to facilitate the sale. Because this does not create an equity interest on behalf of the taxpayer that is subject to the federal tax lien, the authority of the Service to issue a certificate of discharge is under section 6325(b)(2)(B), where the interest in the United States is valueless. The Service has no authority under section 6325(b)(2)(B) to require payment of the sum that otherwise would be applied to junior real estate transfer taxes as a condition of discharge. Because the interest of the United States is valueless, the result would be the same even if the senior lienholder was choosing to use a portion of its mortgage proceeds to pay a junior creditor of the taxpayer (such as payment of homeowner's association fees).

Essentially they are saying that the carve-out for transfer taxes is coming out of the banks secured interest and does not create some sort of equity that makes the IRS lien worth something. This document a letter to the director of collection policy (PMTA stands for Program Manager Technical Assistance) was dated September 17, 2010, but only recently came up on RIA. I haven't seen anything else on this so I am making this a bonus post in the interest of timeliness. If you are involved in a short sale that is hanging because of the IRS, it might be a useful reference.

The letter was sent to the Director of Collection Policy for Small Business/ Self Employed. It was copied to Special Counsel of the National Taxpayer Advocate Program, Assistant Division Counsel (SBSE) and Associate Area Counsels for Ft. Lauderdale and Jacksonville. So this may be a problem that is peculiar to Florida although the principle is of general interest.

P.S.
In the comments below you will see feedback from Richard Zaretsky, an attorney specializing in short sales and related matters. He indicated to me that he has had shouting matches with the IRS on this issue. He has a blog dedicated to short sales. I've seen some misinformation on websites that would lead you to believe that an IRS lien will kill the possibility of a short sale. The relevant section of the Code is 6325(b)(2)(B) which indicates a lien with no value can be released and that in determining the lien's value other liens with priority will be taken into account.