Tax Lien Subordination

Understanding IRS Tax Lien Subordination

Death and taxes are the only two certainties of life. Unfortunately, regardless of how hard you try, you cannot avoid either of these unyielding entities.

Admittedly, taxes are supposed to serve the greater good, so most people are not completely against paying them. But, what happens when you cannot afford your taxes or your taxes do not get paid resulting in tax debt?

When this happens, a lien gets placed against your property.

A lien is a legal claim against an asset or assets to ensure that a debt or obligation will be paid or fulfilled. An asset may be subject to a tax lien if the owner of that item has failed to pay taxes. Because doing so makes it simpler for the property owner to sell the assets or gain access to lines of credit, the property owner has a strong incentive to pay the tax debt or take the actions necessary to eliminate the tax lien.

With that, this article will cover the essentials of Tax Liens and the opportunities they offer seasoned investors.

What is a Tax Lien?

A lien is a charge or encumbrance placed on another person’s property to secure the payment of a debt or obligation, according to the legal definition of the term. Liens indicate a claim against a property, but they do not affect the owner’s legal claim.

Liens get classified into common-law liens, consensual liens, and statutory liens. In the United States, the tax lien is a statutory lien created by the Internal Revenue Service (IRS). Moreover, General Tax Liens, sometimes known as “secret” or “silent” liens, are the most common type of federal tax liens.

By operation of the law, a federal tax lien gets created as soon as it becomes apparent that a taxpayer has failed or refused to pay tax after receiving notice and demand.

Tax Lien vs. Tax Levy

Creditors have two main tools for recovering unpaid debt: liens and levies. But, they each have their unique applications.

A federal tax lien is a formal claim against real estate as collateral or security to repay a debt to the property owner. You must use the selling earnings from the sold property to pay off the remaining debt if the property gets sold.

On the other hand, a tax levy confers upon the creditor the authority to take possession of and sell the property that is the subject of the levy. A levy is a more aggressive form of debt collection than a lien since the creditor already has the legal power to seize and sell the assets subject to the levy.

How to Avoid a Tax Lien? Pay Taxes Owed

A tax lien is a notice from the government that you have a tax debt that has not been paid. If your local government has filed a tax lien against your home, it indicates you have neglected to pay your property taxes. When this happens, the city or county you live in can put a lien against your property.

The federal government can also place a federal tax lien against your properties in the same manner, however, this occurs when federal taxes are left unpaid. So, do not disregard IRS mailings or communications if you cannot file or make payments on time. Fortunately, if you cannot afford to pay off your tax bill in full immediately, payment plans can help you spread out your payments over time.

How Can I Get Rid of a Lien?

By far, the simplest way to get rid of a tax lien is to fully pay any tax debts in full. But, the IRS understands tax debts can burden the financial stability of debtors. Paying a tax liability in full is simply not an option for many with a tax lien. So, the IRS offers three main options to help reduce the impact of an existing lien.

Option #1: Discharge of Property

A discharge of property removes the lien on a specific property. This discharge comes from a certificate of discharge which requires very specific situations. But, the certificate shows the IRS’ intent to release a tax lien on a property.

The situations where a certificate of discharge may apply include:

  • Cases when the property lacks appreciable value for the IRS.

  • An arrangement to make a partial tax payment was made.

  • The sale of the property would generate enough profit to satisfy the interest on tax debts.

You can apply for a certificate of discharge and discharge a lien from a specific property with Form 14135. The IRS provides complete directions to apply for a certificate of discharge within IRC Publication 783.

Option #2: Subordination

Although Subordination does not provide removal of your lien, it allows creditors to jump ahead of the IRS. This makes it easier for someone with a tax lien to qualify for a loan or mortgage. By giving someone with a tax lien the capability of qualifying for a loan or mortgage, the person can more easily refinance or sell their home and downsize to eventually pay off their tax debt. However, the IRS’ tax lien remains on the property even after a Certificate of Subordination is acquired.

You can apply for a Certificate of Subordination by completing Form 14134 and following the IRS’ complete directions found within IRS Publication 784.

Be aware that even with a Certificate of Subordination, all taxes owed are still subject to any applicable interest and fees.

Option #3: Withdrawal

As with Subordination, Withdrawal does not remove your liability for the amount you owe in taxes. But, Withdrawal does remove the public Notice of Federal Tax Lien assuring other creditors that the IRS will not compete for your property. Essentially, a withdrawal completely removes the IRS’ interest in your property whereas subordination places another creditor’s interest in your property above the IRS’ interest.

The IRS offers fairly open requirements to be eligible for a Withdrawal of a federal tax lien. To be eligible for Withdrawal you must provide proof that one of the following circumstances applies to your tax lien:

  • The Notice of Federal Tax Lien being filed prematurely or in a way that does not follow IRS procedures.

  • You have an installment agreement that will satisfy the tax debt for which the lien was imposed and the agreement did not require the filing of a Notice of Federal Tax Lien.

  • A Direct Debit Installment Agreement was made.

  • Collection of the owed taxes is made possible due to Withdrawal.

  • Withdrawal is in the best interest of the taxpayer and the government.

In addition to these five circumstances, the Commissioner’s 2011 Fresh Start Initiative opened up two additional circumstances that qualify for Withdrawal.

The first circumstance that can allow for Withdrawal is if the tax liability has been satisfied and the lien was released. On top of the tax liability being satisfied and the lien being released, the applicant must also be in compliance with the last three years of tax filings and be current on estimated tax payments and federal tax deposits.

The second circumstance applies to anyone that has entered into a Direct Debit Installment Agreement or converted a regular installment agreement to a Direct Debit Installment Agreement. In addition to having a Direct Debit Installment Agreement, the applicant must also fit the following criteria:

  • Be a qualifying Tax Payer.

  • Owe $25,000 or less.

  • The Direct Debit Installment Agreement must pay the entirety of taxes owed within 60 months.

  • Maintain full compliance with other tax requirements.

  • Three consecutive direct debit payments must have already been made.

  • The current or any past Direct Debit Installment Agreements must not have been defaulted on.

You can apply for a Withdrawal of your federal tax lien by completing Form 12277 and then submitting the completed form to the IRS.

IRS lien subordination

What Happens if a Tax Lien is Left Unpaid?

When a tax lien is left unpaid, the IRS can seize property and sell it at auction. All property seized by the IRS must be sold at a public auction or a sealed bid auction. The IRS can seize real estate, cars, boats, and any other property of value when a tax lien is left unpaid.

Can You Sell Your Home with a Federal Tax Lien?

Tax debtors can still sell their homes even with a federal tax lien in order to satisfy any tax debts. However, the lien must be satisfied prior to the sale of the home. Typically, the lien will be satisfied with the proceeds from the sale of the property with a lien at the time of closing. If the property is sold for less than the amount of the lien, the taxpayer must request the lien be discharged prior to the sale in order for the sale to complete.

The IRS intends to increase the amount of taxes owed prior to a lien being filed in order to help struggling taxpayers more easily avoid a lien. In addition, the IRS also continues to expand the available options for removing a tax lien.

Are There Exemptions to Seizure of Assets?

Even though a debtor may owe taxes and other fees, there may be circumstances when their property and other assets will be exempt from being seized. For instance, homeowners with disabilities, seniors, and veterans might be exempt. Additionally, military service members on active duty may qualify for a lien sale exemption.

What Happens to a Mortgage when Real Estate is Seized?

When a lien gets placed on a property, it stays with the asset even if it gets sold later. Tax liens used to remain in the previous owner’s credit report until 2017. But beginning in 2017, all three credit reporting agencies enacted adjustments to stop reporting civil judgments. The government erased all tax liens from credit records by April 2018.

When governments foreclose on properties under their control because of unpaid taxes, this is known as a tax levy. Due to the superiority of federal tax liens over other liens, their foreclosure cancels out all other liens, including mortgage liens. Most homeowners who owe back taxes also have unpaid mortgage debt.

Once the real estate is sold at auction by the IRS, the proceeds go towards the amount owed to the federal government. Should the amount the real estate is sold for not satisfy the amount owed to the federal government, the taxpayer must still satisfy any remaining tax debt.

After the auction of seized property, there is a period called the redemption period. During this redemption period, the owner of the property has the opportunity to try to redeem their property by paying any taxes owed. However, the mortgage holder can foreclose on the property even if the owner is keeping up with the payment of their property taxes. This occurs if the owner cannot make their mortgage payments throughout this time.

Conclusion

In the hands of seasoned investors who are well-versed in the real estate market, property tax liens may provide a lucrative alternative investment opportunity. The fact that there are numerous potential risks, however, makes this market segment inappropriate for inexperienced investors.

Yet, if you know what you’re doing, it can be a highly profitable investment option.

Due to the extensive due diligence in tax lien investing, it may be worthwhile to consider making a passive investment through a member institution of the National Tax Lien Association.

Ultimately, although investments in tax liens have the potential to yield a healthy profit, it is critical to have a solid understanding of all the relevant legalese, specifics, and regulations to succeed.

Ideal Tax Solution Representation

Ideal Tax Solution has the experience and knowledge to handle the most serious of tax audits. Our expert Tax Attorneys and Enrolled Agents will negotiate with the IRS on your behalf and ensure that your taxpayer rights are protected and that the IRS auditor is playing on a level field. Call us today to discuss how we can develop a strategy that will allow you to address the audit and resolve it with better than acceptable results.
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