CCA 200536032: Counsel recommends redeeming two foreclosed lots to protect tax liens

Plain-English summary

IRS counsel considered whether federal tax liens survived a trustee's foreclosure sale of two lots or whether the IRS should redeem them. A first deed of trust had priority over the tax liens on one lot; on the other, a subordination agreement and a buyer's claimed lien complicated the order of payment. Counsel concluded that the first deed remained senior on one lot and likely remained senior to the tax liens on the other, so the foreclosure likely cut off the IRS liens. Given the incomplete information about the competing interests, counsel recommended redeeming both lots by paying the foreclosure purchaser the amounts required under section 7425(d). It also said the IRS would take the first trust holder's rights after redemption under California law.

Ruling snapshot

• Question: Should the IRS redeem two foreclosed lots where competing liens may have displaced its tax liens?
• Outcome: Advice given; counsel recommended redemption of both lots.
• Key authorities: IRC § 7425(b), (d); Treas. Reg. § 301.7425-4(b)(1).

Full text (IRS public release)

Office of Chief Counsel

memorandum
Internal Revenue Service

CC:PA:CBS:B01:GThomas
Number: 200536032
POSTN-106800-05
Release Date: 9/9/2005

UILC: 7425.05-00

date: June 01, 2005

to: Associate Area Counsel (San Jose, Group 1)
(Small Business/Self-Employed)

from: Mitchel S. Hyman
Senior Technician Reviewer, Collection, Bankruptcy & Summonses, Branch 1

subject: Redemption of Subordinated Property

This Chief Counsel Advice confirms email advice dated February 17, 2005, that we provided to your office in response to your request for assistance dated February 1, 2005. This advice may not be used or cited as precedent.

ISSUE

Whether the Service must redeem -----------------that were subject to a non-judicial trustee's sale when the Service's lien was senior to a possessory lienor on one of the lots but junior to the trustee who subordinated its lien to the possessory lienor.

CONCLUSION

Unless more information can be recovered concerning the proximate amount of ----------
-------------------------------------------------------------------------------------------------------------------' interest and the first trust lien on -------, we recommend that you redeem both lots. The Service should redeem ------- because the Service's liens were junior to the first trust lien. The first trust lien on ------- retained its priority because it could not be subordinated to --------- who had no interest in -------. The Service's liens on ------- are likely junior to the first trust lien. Therefore, the Service should redeem both lots by paying ------------------------------------------------, the purchaser at the sale. After redemption the Service will be subrogated to all of the rights of the first trust holder under California Civil Code section 2904. The Service is required to pay the purchaser -----------------------
----------------------------------------------------------------------------------------------------------plus the applicable interest, expenses, and any payments made by the purchaser to a senior lienor.

POSTN-106800-05
-2-

FACTS

On February 1, 2005, SBSE counsel contacted our office by email requesting advice. Counsel asked whether the Service should pay ----------- to redeem the property, and whether the Service was subject to ---------' purchase option agreement.

First Deed of Trust

On -----------------------, ----------------------------------(the taxpayers) purchased two properties known as -----------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------------
-----------------------. These lots were purchased from -----------------------------------------------
-------. On -----------------------, the purchase of these lots and a first deed of trust secured by the lots and naming --------------------------------------------------------as beneficiaries was recorded in the land records of -----------------------------------. The amount of the indebtedness secured by the first deed of trust secured by both lots was ------------.

Sometime between --------------------------and -----------------------, ----------------------------------
-----------------------------, acquired the first deed of trust from the ---------. On -----------------
-------------------------------- filed a Notice of Default and Notice of Trustee's Sale to sell -----
------------------by auction on --------------------------. However, the sale was postponed due to ------------------' bankruptcy petitions. On ------------------------------------------------------------ subordinated its first deed of trust on ------- to the exercised ---------------------------in favor of vendee, --------------------------------------. ---------------------signed the subordination agreement as a partner on behalf ---------------------------.

The Service's Interest

The taxpayers’ --------federal income tax return was filed and the tax was assessed on --
---------------------------. The taxpayers’ ------- federal income tax return was filed and the tax was assessed on ---------------------------. The taxpayers failed to pay the balances due and on -------------------, the Service filed NFTLs against the taxpayers for the --------- and ------- income tax years.

The taxpayers’ ------- federal income tax return was filed and the tax was assessed on --
---------------------. The taxpayers’ ------- federal income tax return was filed and the tax was assessed on --------------------------. The taxpayers’ ------- federal income tax return was filed and the tax was assessed on -------------------------. The taxpayers failed to pay the balances due and on ------------------------, the Service filed NFTLs against the taxpayers for the ---------------- and ------- income tax years.

The taxpayers’ ------- federal income tax return was filed and the tax was assessed on --
--------------------. The taxpayers failed to pay the balances due and on -----------------------

POSTN-106800-05
-3-

-------, the Service filed an NFTL against the taxpayers for the ------- income tax year. ---
------------------(taxpayer------------) died in -------. There is no record of any individual income tax liabilities for taxpayer------ after the ------- tax year. Field counsel estimates that the liens will be worth -------------on ----------------------

------------------
(taxpayer------) also incurred individual liabilities for trust fund recovery penalties (TFRPs) for the quarters ending --------------------------------------------and ------------------------
-------------------------------------------------------------------------------------------------------------------, and from ---------------- through ----------------. The ---------------TFRP was assessed on ----
---------------------. Taxpayer------ failed to pay the balance due and on -----------------, the Service filed an NFTL against the taxpayer for the quarter ending --------------. Field counsel estimates that lien for ---------------will be worth ------------on ---------------------.

-----------------------------------------Interest

On --------------------------------------------entered into the ---------------------------------------------- agreement for -------, whereby ----------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------, agreed to a lease with an option to purchase for -----------. The agreement states that it was between the ---------and ----------------but only ---------------signed. --------- was required to pay ----------down and interest on the principal of ---- for the first year. This agreement was intended to be a lease lasting for one year, from ------------------------- to --
-------------------------, with an option to purchase at the end of the lease-term for an additional ----------plus interest on the principal at ----, or for interest on the principal at the rate of ----. The agreement specified that the ---------------------------------------------------
------------------------------------------------------------ The -------------------------------------------------
----------------------------------------------------------------------------------------------------------was not filed. --------- exercised this option and she asserts a vendee's lien of over -----------, comprised of ------------she paid towards the purchase price, the --------------------------------
-----------------------------------------------------------------------------------------------------------------, and legal fees. --------- insists that the Service will be estopped from arguing that her interest is less than claimed because she provided correspondence to the Service and made a bankruptcy claim supporting the amount. She claims that she can pay ------------ in order to complete the payments terms of the purchase agreement. ------------------------ subordinated their interest in ------ to the vendee's lien. However, --------- claims that they subordinated to her for both lots.

The Trustee's Sale

On or about ---------------------------, the Service received notice that -----------------would be sold at a non-judicial foreclosure sale. On -------------------------, the sale was held, and --
----------------------------------------------- made the winning bid. Out of the ------------------- proceeds, --------------- was paid to ------------------------ and --------was paid to the Service.

POSTN-106800-05
-4-

LAW AND ANALYSIS

A non-judicial foreclosure sale has the same effect with respect to the discharge of the Service's liens as it does on similar liens under the local law of the situs of the property, provided that the notice of the sale was given to the Service, in writing by registered or certified mail, or personal service, not less than 25 days prior to the sale under I.R.C. section 7425(b). A sale under a trust deed holding first priority terminates and cuts-off all rights in the property which are created after the recording of the trust deed under California law. See Bank of America v. Hirsch Mercantile Co., 148 P.2d 110, 115 (Cal. Ct. App. 1944). Where a sale of real property occurs to satisfy a lien prior to the Service's lien, the Service may redeem such property within the longer of 120 days or the period provided under local law under section 7425(d). The price paid for a redemption is the actual amount paid for the property, interest at 6% per annum from the date of sale to the date of redemption, necessary expenses over the income realized on the property for the same period, and any payment made to the holder of a senior lien by the purchaser for the same period. I.R.C. § 7425(d)(2); 28 U.S.C.
§ 2410(d); Treas. Reg. § 301.7425-4(b)(1).

The Service's redemption rights are controlled by whether the Service's liens were senior or junior to the foreclosing lienor. State law determines whether a person has property or rights to property, but federal law determines the priority of the federal tax lien. Aquilino v. United States, 363 U.S. 509 (1960); United States v. Nat'l Bank of Commerce, 472 U.S. 713 (1985).

In the present case, the holder of the first trust deed, -----------------------------------, subordinated its interest in ------- to --------- and then foreclosed its trust deed on ----------
--------. Before the subordination, ---------held a senior position to all of the federal tax liens on -----------------, and --------- had an interest in an unfiled option to purchase --------
--------------------------------------------------------------------------------------------------------------------. Pursuant to California Civil Code section 3050, --------- had a vendee's lien on ------- for -
-----------, the amounts she paid under the purchase agreement. Under Civil Code section 1214, a conveyance, such as the one between --------- and --------------, that is not recorded is void against mortgagees, subsequent purchasers, and lis pendens liens filed before the conveyance is recorded. However, the recording of the subordination agreement provides constructive notice to all persons of the contents of the agreement under California Civil Code § 2934. ---------- lien on ------ was junior to the Service's liens at the time the subordination was recorded. After the subordination agreement ----
---------still had priority over the Service's liens on -------, but that agreement may have placed -------- in a junior position as to the Service's liens on -------. To determine whether --------'s position as to the federal tax liens, the question of circular priority must be answered i.e. who has priority when the Service's lien is senior to --------- but junior to
---------and ---------’ lien is senior to -------- by the terms of the subordination agreement?

In that vein, circular priorities are resolved by defining the amount of the Service's liens and then determining the amount of liens prior to and junior to the Service's position under federal law, and once the liens are ranked as to the Service's liens, state law

POSTN-106800-05
-5-

resolves the remaining priorities. See H. B. Agsten & Sons, Inc. v. Huntington Trust and Sav. Bank, 388 F.2d 156, 158 (4th Cir. 1967); United States v. City of New Britain, 347 U.S. 81, 87-88 (1954). In this case, the Government holds approximately ------------- of liens that are junior to the first deed of trust on ----------------. The deed of trust secured a lien on ----------------- equal to ----------------less any costs of the sale. However, after subordination ---------- lien took the place of the first deed of trust up to ----------- on
-------. Assuming that the amount of the first deed of trust secured by ------- was 1/2 of the indebtedness, or ---------------, --------- would have the first place, the first trust holder would have second place up to -------------, the Service's liens would be in third place, and the first trust holder would be in the fourth position for -----------. In this case, the Service's liens would be terminated by the trustee's foreclosure.

This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call --------------------- if you have any further questions.