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IRS & NY Tax Lien Discharge on Real Estate

Real estate sales and purchases are common.  Unfortunately, so are unpaid taxes.  When the seller of real estate has a tax lien, a real estate closing can become exponentially more difficult.  This is particularly true when net proceeds of sale are insufficient to pay the tax in full. When that happens, additional steps must be taken to obtain a lien discharge.  This article will attempt to shed some light on this somewhat obscure process.  In this post, we’ll look at both the IRS and New York tax lien discharge process for real estate.

Tax Liens

In previous posts, we’ve discussed the basics of both IRS tax lines and New York State tax liens.  As previously noted, when taxes remain unpaid long enough, both the Internal Revenue Service (IRS) and the New York State Department of Taxation and Finance will file a lien against a taxpayer.  A lien is simply the government’s filed legal claim against a taxpayer’s property when a tax debt is unpaid.  It’s filed after the federal or state government takes three specific actions. The first action is that it determines, or assesses, a tax debt. Second, it sends out a bill for the taxes.  Lastly, the taxpayer fails to pay that bill on time.

Discharging an IRS Tax Lien on Real Estate

A “discharge” of a lien removes the tax lien from a specific piece of property,  It does so while preserving the lien against the taxpayer’s other property.  The IRS procedure for obtaining a discharge of a tax lien is straightforward.  It’s set forth in IRS Publication 783.  As the publication makes clear, the IRS application is made on by providing specific information about the discharge request.  Taxpayers, or their representative, should use Form 14135, Application for Certificate of Discharge of Federal Tax Lien, to make the request.

Significantly, the process can add several months to the real estate closing process.  That’s because the application requires several supporting documents as attachments or enclosures to it.  These include the following.  An updated title, proposed closing statement, and an appraisal from a disinterested third party.  Payoffs from priority judgment or lien holders are also necessary, if applicable. The appraisal required is usually one from a professional, licensed, appraiser.  It should be comprehensive.  It needs to include the following:

• a neighborhood analysis,
• description of the site,
• description of the improvements,
• cost approach,
• comparable sales,
• definition of market value,
• certification;
• any contingent and limiting conditions,
• interior and exterior photos of the property,
• exterior photos of comparable sales used,
• comparable sales location map,
• sketch of subject property showing the room layout,
• a flood map,
• and the qualifications of the appraiser.

Needless to say, it’s a detailed document and will need to be ordered weeks ahead of submission of the application.

The Discharge Determination

In making its determination of whether to grant the tax lien discharge, the IRS will look several factors.  Chief among them will be how closely the sale price comes to the appraised value set forth in the appraisal.  If there’s significant deviation, the IRS will ask about the reason for the deviation.  It will, thereafter, make a case-by-case determination on whether to accept or reject the discharge application.  For instance, it’s been this writer’s experience that a deviation of over 10% can be justified if the property being sold has been listed for an extended period.  It should also be noted that the IRS will specifically look at the attorneys’ fees charged.  The IRS will make a determination of whether those costs, appear excessive.

Approval Letters

If approved, the IRS will issue either Letter 402 or 403, as applicable.  That Letter is its written commitment to issue a certificate of discharge.  The discharge will be specifically based on the terms and conditions contained in the letter.  IRS Letter 402 is issued when the interest of the United States in the property to be discharged from the lien has no value.  Letter 403 is issued when an amount not less than the value of the government’s interest in the property is paid in partial satisfaction of the liability. Te taxpayer must divest of all interest in the property after the transactionto qualify to the approval letter.

As a practical matter, it should be clear that the professional appraisal should be done prior to agreeing to a sale price, title should be updated well in advance of when it otherwise might be, attorneys fees need to include the cost of the additional tax lien discharge work involved, and the contract closing date should be pushed back sufficiently far to accommodate consideration of the application for the tax lien discharge.

New York Tax Lien Discharge on Real Estate

Unlike the IRS process for discharging a tax lien, New York State has no publication to guide a taxpayer or practitioner through the tax lien discharge process.  Nor does the State have a form to submit to obtain a tax lien discharge.  Instead, the process begins with a phone call to the State’s Department of Taxation and Finance.  All requests for a tax lien discharge are handled by a Compliance Assistance Team in the Department’s Civil Enforcement Division (CED).  In addition to requiring all the same documents as the IRS, the CED Compliance Assistance Team will require a copy of the IRS commitment to issue a certificate of discharge before it issues its own commitment.

Work With Experience

Most real estate attorneys are not sufficiently familiar with federal or New York State tax law to obtain a commitment to discharge a tax lien in the time frame typically found in contracts to purchase real estate.  Significant up-front work is necessary when the seller has active tax liens.  When that happens the terms of the contract need to be adjusted.  That’s true to accommodate for the increased time it takes to get to closing.  It’s also important to provide an “out” for the seller in the event that the discharge application is denied.  The attorneys at Mackay, Caswell & Callahan have both the tax knowledge and experience to help New York real property sellers with filed tax liens.  If you, or someone you know, needs help with a tax lien discharge on real property, contact this New York City tax attorney today.

Image credit: Sherwood CC