Friday, August 19, 2011

Chapter 7 Bankruptcy, Taxes, and the IRS: Tax Liens and Your Home

It is very important that you know how Federal Tax Liens (“tax liens”) are affected by bankruptcy when deciding whether to file.  So let’s start with a basic fact: If the IRS has filed a tax lien, a bankruptcy will NOT automatically remove it.  Put simply, a tax lien survives bankruptcy.  So even if the tax is dischargeable (see my blog post entitled:  “Can I discharge my tax debt in bankruptcy?") the bankruptcy might not help you.

Let’s look at how a tax lien affects your home.  I will discuss how your retirement plans are affected in a separate blog post.  In all examples, I am assuming that the taxes are dischargeable.

How a Tax Lien Affects Your Home

1) IRS has NOT filed a lien when you file for bankruptcy:  If the IRS has NOT filed a tax lien prior to your bankruptcy, the IRS will have NO RIGHTS to your home after the bankruptcy filing.  The IRS cannot file a new tax lien after the tax has been discharged.  So you should always check whether a tax lien has been filed if you own real estate.

2) IRS HAS filed a lien:  However, if the IRS has filed a lien, you must determine if your house has any equity.  Liens attach to assets in the order in which they are filed (in legal terms, the lien is “perfected” when filed); liens filed first have first rights to the property.  That means if a tax lien is filed, it attaches to your assets after all other liens which were filed before it.   For example, if your house is worth $200,000 and the mortgage is $180,000, a properly filed tax lien attaches to the $20,000 of equity available in the property. Tax liens don’t jump to the head of the line!

So in order to figure out how the tax lien affects your house, you should first ask yourself: is there any equity in my house?

Is There Any Equity in My House? 
The answer to this question is either "No" or "Yes" but the yes answer has a few other things to consider.  Let's look at the possibilities:

1.  Your House has NO EQUITY:  If the IRS has filed a lien but your home has NO EQUITY, the IRS lien is essentially valueless.  The tax lien is UNSECURED since there is no value to which the lien attaches.  Therefore, the lien will NOT survive the bankruptcy. 
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $600,000.  Their home has no equity and the IRS lien is fully UNSECURED.  The tax lien will not pass through the bankruptcy and the tax will be discharged.  Hooray for John and Jane! 
2.  Your House has LESS EQUITY than taxes you owe:  If you have equity in your home, but it is less than what you owe in taxes, the IRS tax lien is PARTIALLY SECURED in the amount of the equity.  Tax liens are secured only to the extent that there is value available to secure the lien.
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $440,000.  Their home has $60,000 ($500,000 less $440,000) in equity.  The IRS lien is SECURED in the amount of $60,000  and UNSECURED for the remainder of the tax.  Therefore, a tax lien for $60,000 will survive the bankruptcy and the remainder of the tax ($40,000) will be discharged. 

3.  Your House has MORE EQUITY than taxes you oweIf you have enough equity in your home to pay all of the tax due (if you sold the home), the IRS tax lien is FULLY SECURED.  Therefore, the tax liens will survive the bankruptcy intact.
EXAMPLE:  A tax lien of $100,000 was recorded by the IRS.  John and Jane own a home valued at $500,000 with a mortgage of $300,000.  Their home has $200,000 in equity.  The IRS lien is FULLY SECURED in the amount of $100,000.  Therefore, a tax lien for $10,000 will survive the bankruptcy and the IRS lien rights will not be affected (although the IRS will not be able to collect from you directly. 
Please note the following final points when assessing a tax lien:

Important Note #1:  It is a very good idea to get an order from the bankruptcy court stating how much (if any) of the IRS tax lien was secured at filing.  You will need to hire a bankruptcy attorney to do this for you.  You will then know with certainty which part, if any, of the IRS tax lien you will need to deal with after the bankruptcy. 

Important Note #2:  Even though the IRS holds a tax lien, they rarely enforce the lien by foreclosure (forced sale) of your home.  Instead, they will wait for you to sell or refinance your home at which time they will have their hand out for money.  The tax lien will eventually be removed when the statute of limitations for the underlying tax expires.  The IRS will not be able to go after you personally, nor is it likely that it will force the sale of your home to get paid.  So all is not lost even if the lien survives. 

Important Note #3:  Remember that the tax lien survives as a claim on your home, but not against you personally.


Where Do I Go from Here?
Now that you've the basic facts about tax liens and how they affect your home in bankruptcy, what should you do now?  If possible, you should figure out if there are less drastic ways of dealing with your tax debt.  Bankruptcy is a very powerful tool and should be used only if absolutely necessary.  Next, you should look at your non-tax related debt.  Sometimes, your overall financial situation is sufficiently poor (lots of debts, lawsuits, little chance of repayment) that a bankruptcy that hits "two birds with one stone" (tax and other debt) makes sense.

If both tax and other debt are large and will be eliminated in bankrupcy without a loss of your home, the decision to file may be the only sensible thing to do.

Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632

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