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IRS, State of Connecticut Will Release Tax Lien on Your Home in Short Sale

It is possible to still complete a short sale on your home if you have hefty tax liens on it.

When these clients called me wanting to short sale their Plainfield, CT home, their situation presented some challenges that I had never dealt with before and required some homework on my part prior to listing to ensure we would be able to make the deal work.

The clients only had one mortgage, which was an FHA loan serviced by GMAC.  Easy enough. FHA is a very predictable program and these clients easily qualified for an FHA short sale.  The issues which presented some challenges were that they had accumulated $52,000 in IRS federal tax liens and $10,000 in State of Connecticut DRS income tax liens on the property. FHA only allows up to $2,500 towards Jr. Lienholders per HUD guidelines.  Being honest with the clients, I told them what I knew and didn't know.  I had read that the IRS will release tax liens for a short sale under several different situations, but I had never actually done one.  Also, I had recently been to a presentation by an attorney who had stated that the CT DRS would not release tax liens in a short sale, and they had advised all of us in that seminar to not even bother taking a listing with a state tax lien because it would never release for less than the full amount owed.  I didn't believe them when they had said it, and now I had a reason to prove them wrong.  I made 2 phone calls, was put in touch with the supervisor at the CT DRS lien unit, and she reassured me that the State of Connecticut would not force a homeowner into foreclosure due to its tax lien. It would expect some form of payment, but that it would release the lien for less than the full amount owed. Now knowing that I would be able to get all the liens released, we listed the property and found a solid cash buyer in the first 2 weeks on market.

Here are the details of the sale:

Sale price- $116,000

Closing costs allowed - $10,000

Net to GMAC / FHA - $106,000

Amount owed to GMAC / FHA - $156,000

Deficiency forgiven by FHA/HUD - $50,000

IRS tax lien amount - $52,000 - released lien only (no debt forgiven) for $1,000

State of CT tax lien - $10,000 - released lien only (no debt forgiven) for $750

All in all a pretty smooth deal, with only a little over 100 days from list to close.  The IRS and state released their tax liens – but they do not forgive the tax debt in a short sale.  To quote Benjamin Franklin, “Our new Constitution is now established, everything seems to promise it will be durable; but, in this world, nothing is certain except death and taxes.”   If your goal is to reduce your tax liability, attempting to do it while short selling your home is not the proper time to do so.  That process takes a long time to complete and would almost certainly derail your attempt at successfully completing a short sale. Please consult a tax attorney regarding settling your tax debt for less than the full amount owed.

I’d like to speak a bit now about how to get the federal tax liens released for a short sale. To do so, you need to reference IRS publication 783, and I read it several times. Sometimes government speak can be a little confusing.  Here was the documentation required according to publication 783:

  • Completed form 14135
  • FULL APPRAISAL by a disinterested 3rd party. You MUST HAVE a FULL APPRAISAL completed on the property. My clients lucked out in this area, because they had an FHA loan. The FHA PFSP is one of the only programs where it is required that the seller and seller’s agent be given a copy of the HUD appraisal if they request it.  There is no way around this. If you don’t have an FHA loan, you are most likely going to foot the $400 bill for a full appraisal.   If you are not willing to do this, don’t bother calling any Realtor and listing your house, because the tax lien will not get discharged without it.
  • Informal valuation by disinterested 3rd party – This can be a CMA performed by another Realtor.
  • Title report – A list of all debts senior and junior to the IRS tax lien.
  • Payoff statements- Payoff statements from the debts senior and junior to the IRS tax lien. MUST be an official payoff statement. Cannot be a mortgage statement.
  • Copy of Federal tax lien
  • Copy of purchase and sale contract
  • Copy of estimated HUD 1
  • Copy of short sale approval letters for all debts senior  to the tax lien

In this case we were asking for a discharge of the lien under Section 6325(b)(2)(B). A discharge may be issued under this provision when it is determined the government’s interest in the property has no value.  We sent this entire package off to the IRS advisory group in Boston, and a case was opened the next day.  We were told that the time frame for a discharge was 45-60 days.  Ours ended up coming in about 40 days.  It is necessary to take the approval time into account when dealing with your senior lienholders.  Extensions on their short sale approvals will almost certainly be necessary due to the IRS.

About a week after the case was opened, I received a call from the IRS agent working the file and I have to say, she was hilariously funny and great to work with through the entire process. Who knew IRS agents have a sense of humor?  After reviewing our file, she needed additional documents. Those documents were as follows:

  • Copy of the recorded deed from when the taxpayer purchased the property
  • Copy of all recorded mortgages on the property as well as any mortgage assignments
  • Copy of all other bills to be paid at closing. Property taxes, fire taxes, water and sewer, commission. If it’s listed on the HUD, you need to have documentation for it.

Once all of those documents were into the IRS agents file, it was about a 2 week review period and our approval letter was granted!  Hooray!  Another client avoids foreclosure, and I now know exactly what it takes to get IRS Federal and CT state tax liens released for a short sale in Connecticut!

Patrick

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