Tax Machine Blog™

Short sale of home when you have a federal tax lien

Is it possible to complete a short sale when there is a federal tax lien on your home?

It was either paying for this home, or paying for his taxes. Tony chose the home.

It was either paying for this home, or paying for his taxes. Tony chose the home.

 

Throughout my years in the tax resolution industry I have seen far too many successful self-employed people get into tax trouble for one simple reason: they put off making estimated tax payments to pay their mortgage – planning on a refinance. But then after the housing bubble collapsed, a refinance was no longer possible. So – now they want to move to a home they can afford, but they have tax liens. When your house is underwater, can you successfully pull off a short sale even though you have a tax lien filed against the property? (wondering what happens during a short sale? Read more here.

Usually the story goes something like this:

  1. Tony and Tina Taxpayer buy a home. Tony liked the location (it’s close to the city), but Tina only agreed to buy the home on one condition – that they strip the house down to the studs and renovate the entire property. They bought the house in 2005, the renovations are done by the end of 2006.
  2. In order to get the renovations done by the end of 2006, Tony put off paying his Estimated Tax payments. He figured that once the renovations were done, he would be able to pay his back taxes by refinancing his home.
  3. 2007 happened. Then 2008 happened. Home values have still not recovered. Tony was never able to refinance his home to pay back the taxes he owed. He was able to take out a second mortgage in 2006, but he ended up using that money to pay for more renovations.
  4. Now it’s 2013. Tony now owes the IRS more than a million dollars in back taxes, interest, and penalties. The IRS has liens against his home, and he can’t afford to pay his mortgages and also make his estimated tax payments, so he’s stuck between getting current on his estimated tax payments and paying for his home.
  5. Tony decides to sell his home, and move into a house that’s more affordable. But he’s faced with two obstacles. First, Tony’s home is underwater. Second, Tony has a million dollar tax lien. What can Tony do?

If the tax lien wasn’t part of the equation, Tony would have a much easier time talking to his bank about a short sale. See, banks are finally realizing that home prices will not be recovering, and that short sales might be in their best interest.  But a short sale might not work out for Tony. That’s because his federal tax lien will make things a lot more difficult when it comes time to close with the buyer. The buyer is going to ask for a warranty deed, and that deed promises that the property is free and clear of any title defects. The tax lien is such a defect and will need to be cleared up before the sale can close.

Now, the bank is already going to drag its feet on this sale. In the past, a bank would even prefer foreclosures to short sales if it would allow the bank to keep the property on their books for more than it is worth, and avoid the write-down. Even though banks are more amicable to short sales now than they used to be, bank employees aren’t going to waste their time on a short sale that might not go through because of title defects.

“Ok,” you might say, “but what if the buyer was willing to take the property ‘subject to’ the tax lien?” First of all, I’m not sure a buyer would ever agree to this. But even if the buyer did, the equity in the property would essentially be reduced by the amount of the tax lien. That means the buyer is going to want to spend that much less on the home. Is the bank going to take the hit for that? I don’t think so.

So, what can Tony do if he wants to conduct a short sale of his home and he has an outstanding tax lien? Well, he has to get that lien removed. At this point, the tax lien is standing in the way of his successful completion of a short sale. Well, there are options available. In this case, Tony would be looking what is called a “partial release” of his tax lien. The process is described in IRS Publication 783.

There is help available. First, I’d recommend contacting a realtor who specializes in short sales, specifically a Certified Distressed Property Expert (CDPE), to walk you through your options.
With the added complexity of tax lien in the mix, I’d recommend contacting a tax attorney as well.

 

Related:

One other note on short sales and tax matters, a new law provides tax relief from short sale transactions that end up with a discharge of debt.

 

 

  • Hellen Hilson3

    my husband was searching for IRS 12153 earlier today and used a web service that hosts lots of fillable forms . If people need IRS 12153 too , here’s http://goo.gl/P44caQ

  • Reg Roberts

    If Tony were smart he would have payed his taxes and not been in this mess in the first place.

    • If Tony IS smart, he’ll realize that it’s never too late to face his tax problems head on.

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