A Notice of Federal Tax Lien is a public document recorded by the IRS to alert creditors that the government has a legal right to an individual's property due to unpaid tax debt.

As a real estate professional, if you have not run into a Federal Tax Lien issue yet, you will. According to the IRS, in 2022, the agency filed 157,323 Notices of Federal Tax Lien, down from 212,251 in 2021. These liens remain in place until the collection statute of limitations expires (usually ten years) or the tax is paid in full or otherwise discharged through a bankruptcy or Offer in Compromise. With between 150,000 to 200,000 filings per year, each lasting up to ten years, the number of filed Notices of Federal Tax Lien's must be astronomical.

The IRS moves slower than the typical real estate transaction, so it is best to know if a lien exists as early as possible, preferably before the property is under contract. If you can obtain a copy of the preliminary report or title abstract before you have a purchaser, do so. It just may save your transaction.

If there is a federal tax lien, generally, there is one of three routes you will take.

Lien Filed in Error.

The IRS does make mistakes. If this is the case, the seller must file a Form 12277 along with a copy of the Notice of Federal Tax Lien, the basis for withdrawal, and an explanation of the facts supporting the withdrawal. Processing times vary, but a call to the IRS Lien Desk can provide an estimated timeframe. The Lien Desk phone number is 800-913-6050.

Lien is Valid and Seller Can Pay Amount from Sales Proceeds.

In this case, the escrow officer or closing attorney will contact the IRS to obtain a payoff amount and instructions. This is similar to other, more traditional encumbrances such as a mortgage or deed of trust. As part of this process, the IRS will file a Certificate of Release of Federal Tax Lien.

Lien is Valid, But the Equity Will Not Pay the Debt in Full

This is probably the most common occurrence; unfortunately, this scenario requires the most time and effort. If this is the case, the seller must apply for a discharge of the property from the lien. This means the lien will still exist as a matter of public record and encumber the other assets of the seller, but the IRS will release the effects of the lien from this specific property. To discharge the property, the IRS will require one of the following circumstances:

1. If the Notice of Federal Tax Lien encumbers multiple properties, the IRS may discharge a particular property if the equity in the remaining properties is at least double the liability covered by the Notice of Federal Tax Lien.
2. The IRS receives all of the proceeds from the sale, less senior liens (or purchase money liens, whether or not senior), and bona fide and reasonable costs of sale.
3. The security interest held by the IRS is worthless. For example, this would be the case in a short sale where there is no equity after the satisfaction of senior lienholders.
4. The seller and the IRS agree to hold the proceeds from the sale in escrow subject to the Notice of Federal Tax Lien and claims of the United States.
5. The IRS may discharge the property if a deposit is made or a bond is furnished in an amount equal to the United States' interest (sales proceeds, less expenses of sale, and payment to senior lienholders).

Recently, the turnaround time for a discharge was 45 days from the date the IRS received the written request and required documentation. If your escrow is scheduled to close sooner, the IRS will attempt to expedite their review, but don't count on it getting done much sooner than 45 days. A call to the Lien Desk (800-913-6050) can inform you of the current turnaround times. Keep this in mind when drafting the contract.

The IRS May Help with Moving Expenses

More accurately, they may allow the seller to keep some of the proceeds to assist in paying for a move that the seller could not otherwise afford. The seller must demonstrate the need for the moving allowance and provide documentation to support the requested amounts. This Request for Relocation Expense Allowance should be submitted with the request to discharge the property from the Notice of Federal Tax Lien, if possible.

As a real estate professional, you typically can handle many sale-related matters on behalf of your client. Unfortunately, in this case, the seller will have to complete these tasks on their own or enlist the help of somebody certified to practice before the Internal Revenue Service.

Keep in mind that this information is for general information purposes, and to ensure the smoothest possible transaction, the seller should have professional help to address the Notice of Federal Tax Lien properly.