land trust tax attorney

Can the IRS reach an interest in real property held in a land trust? If so, what happens if the taxpayer sells the property? Can the IRS recoup the land from the new buyer or is the IRS limited to the proceeds received? The court addresses this in United States v. Harold, No. 2:18-cv-10223 (S.D. Mich. 2019)

Facts & Procedural History

The defendant owed back taxes to the IRS. The IRS brought suit to enforce its lien.

The defendant owned interest in real estate via a land trust. While the litigation was pending, the defendant sold his interest in the real estate to a third party. He did so by executing a quit claim deed. The buyer paid money, presumably fair market value’s worth, to the defendant for the property.

The IRS had filed notice of its lien prior to the date of the sale. The IRS lien was filed in the defendant’s name.

Upon learning of the sale, the IRS filed an emergency motion asking for information about the sale and to include the buyer in the pending litigation.

The question for the court was whether the IRS lien attached to the property or just the proceeds from the sale of the property.

IRS Liens and Land Contracts

The general rule is that an IRS lien arises when a tax is due and unpaid. The general rule continues to say that the IRS lien follows the property when property is sold. But what about an interest in a land contract?

The land contract separates the equitable and legal title to real estate. The person who holds the land contract interest has the equitable interest in the real estate and the original owner has the legal title to the real estate.

The court noted that the IRS lien attaches to equitable interests in real estate. Thus, it attaches to the interest in real estate in this case even though the interest is held via a land contract.

IRS Lien & the Proceeds from the Sale

The defendant also argued that the IRS lien detached from the real estate and attached to the proceeds upon the sale. It cited Phelps v. United States, 421 U.S. 330 (1975) for this rule. The argument is that the buyer should not be penalized by the IRS when it paid for the property.

The facts in Phelps were different. In that case, the IRS had not filed notice of its lien before the property was sold. As a result, the buyers were able to take free of the IRS lien given that they paid fair market value and had no notice of the IRS lien.

This is the exception found in Sec. 6323, which says:

The lien imposed by section 6321 shall not be valid as against any purchaser, holder of a security interest, mechanic’s lienor, or judgment lien creditor until notice [is filed].

Section 6321 goes on to provide other rules, which should be considered by those who are selling property subject to IRS liens. But the additional rules are not relevant to this case.

The court noted the distinction in this case and the facts in Phelps, concluding that the buyer had notice of the IRS lien. Not only did the IRS file its lien in advance of the sale, the deed transferring the property noted that the IRS may have an interest in the property.

This case shows the importance of selling property prior the IRS issuing its lien notice. Had the defendant sold the property prior to the IRS lien notice filing, the buyer could have gained clear title to the property.

Start the Conversation.
  • Former IRS attorney
  • Deep tax knowledge
  • Free consultation
Call 281-631-3300