Real estate sales and purchases are common. Unfortunately, so are unpaid taxes. When the seller of real estate has a tax lien filed against him or her, and the net proceeds from the sale are insufficient to pay the tax obligation in full, additional steps must be taken to obtain a discharge of lien for the property being sold. This article will attempt to shed some light on the somewhat obscure process of how to obtain both an IRS and New York tax lien discharge of real estate.
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 is filed after the federal or state government determines, or assesses, a tax debt, a bill for the taxes is sent out, and that bill is not paid 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, while preserving the lien against the taxpayer’s other property. The IRS procedure for obtaining a discharge of a tax lien is straightforward, and is set forth in IRS Publication 783. As the publication makes clear, the IRS application is made on Form 14135, Application for Certificate of Discharge of Federal Tax Lien. Significantly, however, the process can add several months to the real estate closing process, since the application requires several additional documents to be submitted with it. These include an updated title, proposed closing statement, payoffs from priority judgment or lien holders, and an appraisal from a disinterested third party. The appraisal required is usually one from a professional, licensed, appraiser. It should include a neighborhood analysis, description of the site, description of the improvements, cost approach, comparable sales, definition of market value, contain a 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.
In making its determination of whether to grant the tax lien discharge, the IRS will look at 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 and will make a case-by-case determination on whether to accept or reject the discharge application based on that reason. For instance, its been this writer’s experience that a deviation of over 10% can be justified due to the fact that the property being sold has been listed for sale for over a year. It should also be noted that the IRS will specifically look at whether attorneys’ fees, paid as part of the closing costs, appear excessive.
If approved, the IRS will issue either Letter 402 or 403, as applicable, which is its written commitment to issue a certificate of discharge based on the terms and conditions contained in the letter. IRS Letter 402 is issued when it is determined that 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. To qualify to obtain either Letter 402 or 403, the taxpayer must be divested of all interest in the property after the transaction.
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 needs to be done when the seller has filed tax liens filed against him or her, and the terms of the contract need to be adjusted; both to accommodate for both the increased time it takes to get to closing and 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 us today.