Ask Erin: How does an IRS Tax lien affect a short sale?

If you follow me on Twitter, you will know that today I discovered that the seller of one of my Sacramento short sale listings has IRS Tax liens from 4 separate tax years. What exactly does this have to do with my short sale, you ask?

Liens of this nature attach to real estate owned by the seller. When that property is sold, the liens are then paid in full out of the net proceeds of the sale. In short sales, where there are ZERO dollars in net proceeds from the sale -- this creates a potential problem! The liens have to be paid off in order to transfer the title of the property to the new owner, but there is a lack of money to pay the liens...so what happens?

Well, luckily, both the Internal Revenue Service (IRS) and the California Franchise Tax Board have processes to request that the liens be "partially released" so that the properties in question can be sold and the liens go unpaid. The liens still exist and stay with the seller, and could attach to other property he or she owns or comes to own at a later time, but they are released from the subject property being sold.

If you are selling a property and have unpaid state or federal income tax, it is critical that you let your Realtor know about it, even if you have not received notice that any actual lien has been filed. Liens can pop up at any time, so even if a lien doesn't officially exist today, it might be officially recorded between now and the time you get your short sale approved and try to close the escrow.

The process with the IRS can take several weeks to complete from application to approval, and subsequent close of escrow. The approval of your application is only valid for 30 days. Timing of your request is tricky, especially if you are trying to do a short sale, since you do not always know exactly when the short sale lenders will approve the transaction, nor do you necessarily know the final selling price!

To apply, you must fill out IRS Form 14135 "Application for Certificate of Discharge of Property from Federal Tax Lien." The form requires A LOT of information and supporting documentation that your Realtor and escrow officer can assist you with -- including things like a title report, a copy of the estimated HUD-1 settlement statement, a copy of the recorded tax lien itself, a property appraisal, etc.

Then, depending on the location of the property within the state, you will mail the application and supporting documentation. You can follow up via telephone at 800-829-3903. The IRS has actually prepared videos to assist sellers with this process -- view them by clicking here.

Next week I will post about the process for making the same request of the California Franchise Tax Board...