Arguably one of the most expensive and therefore most important purchases one makes during their lifetime is a home. Due to the magnitude of the purchase, the entire process can be very intimidating, scary, and consequently result in a lot of stress and anxiety. At least I know it did for me. Combine that with the knowledge that you have an outstanding tax liability with the biggest creditor in the country, the IRS, and all those emotions quickly become supercharged.
Though few of us are able, it should be understood that if you have the funds to pay cash for a house without the need for financing, no debt, including IRS debt, should be an obstacle in purchasing a home. However, the vast majority of us do not fall into that category. Hence, the issue at hand and the focus of this article is whether one can secure a loan from a financial institution to purchase a house when there is an outstanding tax liability.
Unfortunately, like with most complex questions, there is no definitive answer to this question as it depends upon a multitude of factors such as one’s income, debt, credit score, and the lending guidelines used by the particular financial institution from which you seek a mortgage. Whereas lending guidelines vary by lender, if an IRS tax liability is preventing a specific financial institution from approving a loan, it may be worthwhile
to shop around with other lenders.
A lien is a claim of legal right to an asset or piece of real estate to satisfy a debt. The IRS files a federal tax lien to alert outside parties and to protect their interest in the liability as they do not want a taxpayer to sell assets or secure a loan (including a home loan) and not pay the tax liability. Unlike some other liens which attach to specific property, an IRS tax lien is referred to as a blanket lien as it attaches to all property owned by the taxpayer that is located in the county where the lien was filed.
One noteworthy aspect of an IRS tax lien is that they are filed in specific counties, typically the county where one currently resides, and accordingly the lien only attaches to assets that are located in the county where the lien was filed. Thus, one could certainly purchase property in a different county, where a federal tax lien was not filed, and the IRS Notice of Federal Tax Lien would not attach to that property (though, existence of the tax debt may affect the lender’s willingness to approve a loan).
The IRS will typically not file a tax lien unless the liability is over $10,000, but on the plus side, as of late, the IRS has eased up on this and has generally increased this threshold to $25,000. However, there are some limited exceptions to this general rule in which a tax lien will be filed for a lower amount of liability. These exceptions revolve primarily around if it will protect the government’s interest, as in the case of an impending bankruptcy, or if it has been determined that the taxpayer is actively dissipating assets. Additionally, there are other circumstances that the IRS factors into their lien filing determination.
A tax lien typically becomes a problem in purchasing a home when the financial institution conducts a credit search and discovers that the IRS has filed tax liens due to unpaid debt. The reason that a tax lien may become an obstacle in securing financing to purchase a home is because it alerts the financial institution to the existence of the tax liability.
The tax lien in and of itself should not prohibit the financial institution from approving a loan due to Revenue Ruling 68-57 that was published in 1968. Provided that all state law requirements are satisfied, this ruling allows a lender the ability to obtain a Purchase Money Mortgage for a loan used to purchase real property. As long as all the loan proceeds are used toward the purchase of the property, a Purchase Money Mortgage gives the mortgage lien priority over an already recorded federal tax lien thereby protecting the interests of the lender.
While this is all well and good, just because a financial institution is assured that their tax lien will have priority over the federal tax lien, that does mean that the financial institution will approve the loan. Since the tax lien has made the lender aware of an outstanding tax liability, the loan may be viewed by the lender as a risky prospect. This is where the other factors that I mentioned such as income, other debt, and credit history come into play as each financial institution often evaluates the risk of a loan differently.
Consequently, the best way to improve the probability of securing a home loan from a lender is to demonstrate to them that the federal tax liability is being actively resolved. In general, there are several primary ways to resolve an outstanding IRS tax liability that will result in the associated tax liens also being resolved.
An IRS tax lien will be released once the periods of liability listed on the tax lien have been paid in full, the statutory period for collections has lapsed, or the liability has been resolved through bankruptcy or an Offer in Compromise. Payment to resolve the tax liens can be done through either a lump sum payment, through monthly payments pursuant to an Installment Agreement or Offer in Compromise, or a combination of
same. Either way, once the liability listed on the liens are paid in full or the accepted Offer in Compromise amount has been paid in full, the IRS will release the tax liens that were previously filed as they have now been satisfied. Aside from paying the IRS tax liability in full through a lump sum payment, through a lengthy payment agreement, or pursuant to an Offer in Compromise, in general, the IRS will not discharge or subordinate a tax lien unless it is in their best interest. Being in the best interest of the IRS typically means that the discharge or subordination will facilitate the payment of the tax liability.
The most common examples of this are securing a loan or selling assets to specifically pay toward the liability. When securing a loan to reduce the liability but not pay the liability in full, the IRS may agree to subordinate their lien to the lenders to facilitate the approval of the loan provided that there is a guarantee that the loan proceeds are remitted to the IRS. Similarly, when selling an asset, the IRS may agree to discharge their lien on the specific asset being sold to facilitate the sale, again, provided that that there is a guarantee that the sale proceeds are remitted to the IRS, or that there are no sale proceeds remaining after paying off security interests senior to the federal tax lien. Securing a payment agreement with the IRS demonstrates to a financial institution that the debt is being addressed and resolved. A somewhat recent rule was implemented by the IRS that can assist in not only expediting the approval of a payment agreement but also the release of tax liens. This new rule applies to income tax liabilities of $25,000 or less, in which a direct debit payment agreement is secured that will resolve the liability in full in either 60 months or prior to the Collection Statute Expiration Date, whichever comes first.
The Collection Statute Expiration Date is 10 years from the time that the liability was assessed. Many things can place a hold on This 10-year period such as filing bankruptcy, submitting a resolution proposal, or filing an appeal to name a few. The general rule is that if an action is taken by the taxpayer that prevents the IRS from proceeding with involuntary collection, that action also places a hold on the collection statute.
This newer rule to expedite the release of a tax lien was implemented by the IRS to encourage taxpayers to reduce their outstanding income tax liability to the $25,000 threshold to then secure a direct debit payment agreement for the balance. Once the direct debit payment agreement is secured, then the taxpayer can submit a formal application to get the IRS to withdraw the tax liens, provided that the following criteria are met:
1. At least three consecutive payments have been made pursuant to the payment agreement;
2. The taxpayer is in compliance with all other filing and payment requirements; and
3. The taxpayer has not defaulted on the current, or any previous, direct debit installment agreements.
Unfortunately, the withdrawal is not automatic. Nonetheless, if the IRS tax liability and associated liens are preventing a financial institution from approving a home loan, this IRS process can be a particularly useful tool toward resolving the liability and getting the IRS tax liens withdrawn. This in turn may assist in facilitating approval of the home loan.
Another resolution strategy that will expedite the release of an IRS tax lien is that of an Offer in Compromise (tax settlement). This resolution strategy has been discussed in detail in other Fortress Tax Relief articles and so the specifics of this strategy will not be addressed in this article. In a nutshell, once the IRS approves an Offer in Compromise, and once the amount offered has been paid in full, the IRS will then release the tax liens
as the terms of the Offer in Compromise have been satisfied.
Once a mortgage loan is approved and a home is purchased, another common situation that often comes up down the road is wanting to sell the property and purchase an alternate residence. Then the question becomes how can I sell my home if it is subject to a federal tax lien?
When a home loan is secured, the financial institution files a lien themselves. The lender’s lien attaches solely to the home being purchased. Thanks to the previous discussed Revenue Ruling 68-57 and a Purchase Money Mortgage, the lender’s lien will have priority over the federal tax lien. Nonetheless, when selling the property, there are three primary scenarios.
1. The sale proceeds exceed the remaining mortgage balance (lender’s lien) and the outstanding federal tax liability (tax lien).
2. The sale proceeds are sufficient to full pay the mortgage (and other senior creditors if applicable), but not enough to pay off the tax lien.
3. The sale proceeds are sufficient to satisfy only a portion of the mortgage (and other senior creditors), but insufficient to satisfy any of the tax debt.
In the first scenario, there is no issue as the sales proceeds will resolve both tax liens in full and so the buyer is assured that they will be purchasing the property free and clear of both liens.
In the second scenario, while the mortgage will be paid in full and the lender’s lien satisfied, the sales proceeds will not resolve the tax liability and the associated tax lien. Since a buyer typically will not purchase property subject to a lien, the seller must get the IRS to discharge the federal tax lien on the property. This is done by securing a certificate of lien discharge from the IRS.
In this scenario, to get the IRS to issue a certificate of lien discharge, the taxpayer must first prove to the IRS that the tax lien that is attached to the residence is worth less than the underlying tax debt because the sale proceeds remaining after the senior lienholder is paid off will not be sufficient to fully pay the underlying tax liability (in other words, the there is only enough left over to partially pay the tax debt). Once this is demonstrated, the IRS will agree to discharge the tax lien on the specific property to facilitate the sale of the property (with any proceeds beyond those used to pay off the senior lienholder going to the IRS). However, it is important to understand that the tax lien will be discharged on just the property that is being sold but will remain on all other assets. Thus, the lien itself will still exist and will attach to any newly purchased property.
The third scenario is similar to the second but since the value of the home is also less than the mortgage balance, the lender must approve the home to be sold through a short sale. Typically, short sales are reserved for extreme cases where the lender concludes that it is in their best interest to take a loss instead of going through costly foreclosure proceedings. In order for a short sale to proceed, all other lien holders must agree to it. Thus, once the lender approves the short sale, a certificate of lien discharge will be needed from the IRS under the same premise as the previous scenario, which is that the tax lien holds no value.
As previously discussed, a lender’s primary concern in approving a home loan is very often based on the borrower’s creditworthiness as determined by the lender. A lender is not likely to approve a loan if they believe there is a risk of the IRS commencing involuntary collection action such as bank levies or wage garnishments as that would jeopardize the borrower’s ability to satisfy the terms of the home loan. Consequently, the best way to make a lender comfortable that this will not occur is to demonstrate to them that the federal tax liability is being actively resolved through an Installment Agreement or Offer in Compromise. If a tax liability has not yet been resolved, the lender may feel more comfortable if the borrower has hired a tax attorney to represent them as that may provide the lender more assurance that the liability will be properly resolved.
Bottom line, due to the magnitude and importance of securing a home loan to purchase a residence, it is critical to be as well informed as possible about the potential ramifications of an IRS liability on the lending process. A qualified tax attorney who is well versed with the nuances of tax resolution and the impacts of federal tax liabilities and liens, could very well make the difference between securing a home loan to purchase one’s dream home or alternatively having to go through the nightmare that results from having the home loan application denied.
If you owe taxes and are wanting to purchase a home or if you simply wish to learn the best way to go about resolving your tax liability, give us a call. Fortress Tax Relief has caring and knowledgeable professionals on staff who would be happy to outline a solution tailored to your specific needs and circumstances. There is no cost for a telephone consultation, so give us a call today.
