IRS Lien Spells Profit!
Attending a real estate meeting in Salt Lake City last month I watched many investors shy away from properties with tax liens, they like myself had no idea what “that” entailed and what we were getting into.
Since then I thought I would do a little research and share what I learned with others at my favorite CRE website.
When the IRS places a tax lien against an individual (owner of a property), that lien theoretically attaches to any "real property" that the individual owns anywhere in the U.S. While the lien may not appear against any particular property itself, it still in theory is attached to the property. Reportedly some of the best deals are the properties with a Federal or IRS Tax Lien against the owner/Trustor. Many potential buyers shy away from properties with tax liens against either the property or the owner because they don't understand the situation and that scares them. These are often the best deals!
Importantly on properties to be sold at auction you not only need to verify the liens against a foreclosure property, but you also must verify if there are any liens against the Owner. Otherwise, you might inherit his tax lien(s). I know of an investor that partnered with another person on a property only to find out that after closing his partner had an IRS lien against him that encumbered the entire property. Some investors fail to do due dilligence, and suffer really tough consequences.
The IRS places a tax lien against an individual & that lien attaches to any "real property" that the individual owns anywhere in the US (I am not sure about its protectorates). While the lien may not appear against any particular property itself, it still attaches to any property owned in the individuals name (another good reason to use Land Trusts).
These properties with tax liens have some great potential especially where there is real underlying equity. According to one web author the “key” is to be certain the Federal Tax Lien is "junior" to the mortgage or loan being foreclosed on. Senior liens must be paid off. SO THIS IS CRUCIAL! It is rare that a Federal Tax Lien will be senior to most commercial mortgages.
When a home or property sells at a foreclosure auction the IRS has by law, a 120 day "Right of Redemption" period. This is where they can buy the house back from the buyer at the foreclosure auction for what they paid for it, plus reasonable interest. According to my readings and what I have seen in my small corner of the world the IRS rarely redeems or exercises their "Right of Redemption". There are too many properties and not enough money in the budget to redeem every property (I have heard that the redemption budget is around 10 million). They focus on the really big properties that will make them the most money.
After buying at auction, wait 120 days (don't make any improvements during this period, because the IRS won't reimburse you for that) after the 121st day, the property is all yours (if they haven’t redeemed). The worst case scenario is, they redeem and you get all of your money back, plus interest. It's worth the risk for the potential increased reward unless perhaps you’re using “hard money” and have really high interests rates.
Here is an example of how it “might” work:
There is a property that is worth $300,000with a mortgage balance for $190,000 but it has a junior lien from the IRS for $160,000 placing the encumbrances way above the properties FMV ( I have a friend in this situation; he figures there is no reason for him to try and save the property if it goes to foreclosure, he doesn’t think he has any equity).
If this property goes to auction I buy it for less than FMV ignoring the IRS lien amount and wait 120 days to see if they redeem the property. If I bought the home for $200,000 and the IRS doesn’t exercise its right of redemption, on day 121 I now have a property with $100,000 equity.
Hopefully this information was beneficial, I know that from here on out I will never shy away from a property at auction simply because it has an IRS lien against it.
Randall
Randall, thanks for the article. It was very good. In your example, at the end of your post, can you explain what the $200,000 goes to? Does that cover the Mortgage lien or the IRS lien? My guess is, the IRS lien (since you are buying it from the IRS auction). Tell me about the mortgage lien. Is this lien:
1) Charitably forgiven by the bank, so you own nothing for the mortgage
2) Still the responsibility of the original owner who no longer has rights to the property
3) Renegotiated by you, for some fraction of the cost
3) Your responsibility for full payment of the lien
Thanks - the whole process is very interesting to me. I'm looking at a place right now, that has $56k in a tax lien and a $400k mortgage lien with a FMV of approx $600k.
Marc
I am in Prague anbd can't read everything here but I think on your deal what generally happens is the IRS lien of 56K is exercised only a small protion of the time. YOu buy the property at 400K (or whatever it sells for at auction) hold it for the specified numver of days and then when the IRS doesn't exercise its option you can sell the property for FMV with no lien to worry about.
The 200K goes to the 1st/bank lien. These are generally foreclosure auctions not IRS auctions.
R.
Nice article. A lot of people do shy away from IRS lien encumbered properties because they don't understand how the liens work.
In a situation like you describe, buying with cash, it may very well work out OK due to the large equity. Get the 100K equity in four months if they don't exercise.
According to the Denver office of the IRS, they pay only 6% interest from the date of sale if they exercise their right of redemption. So, with that 200K purchase price, if you paid cash and thus recover the full 6% interest, you will only make $4K if they exercise their right. If you financed your purchase you will either break even or lose money if they exercise.
That being said, keep in mind that some offices will negotiate a settlement on the lein. An associate of mine in Seattle has had two leins over $30K settled for $2500 each. But the office that is over Salt Lake City, where I am, has denied requests for settlement made by another of my associates. He ended up waiting out the four months. It goes with out saying that a person should find out how their office works before trying this.
It is a gamble, but the odds are not too bad if you are playing with cash and can afford to keep it tied up for four months.
-Rup
I do agree with you, however the money I have to borrow I have at 3.5% and so 6% is not a loss to me. With the rarity of the IRS excercising its option I feel it is a pretty good gamble in many cases.
SP99,
What's the best way to determine if the prior owner has an IRS lien? I have his name but not his social.
Thanks in advance.
RP