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Court of Appeals Rules IRS Lien Is Superior To Bank Lien on Rental Income, When IRS Lien Pre-Dates the Receipt of Rental Income

Bank Security Interest

The Seventh Court of Appeals has ruled that a lower court’s decision resulting in the IRS having an inferior lean to a superior bank lean was incorrect.  In the case, the property had a bank lien on it for “all rents” and sale proceeds.  The borrower of the loan and owner of the property defaulted and the IRS filed a tax lien against the real estate.  The tax appointed receiver then rented the property out for nearly six figures.

The Internal Revenue Code gives priority to a creditor’s lien if the lien was proper and is in existence prior to the IRS claim.  In this case, the rentals did not exist at the time the bank mortgage.  Since the bank and lien was on the rents that did not exist, the lien was not valid until rents occurred; which was after the IRS stepped in.  Accordingly the bank’s lien was put in second place to the IRS.

Editorial Comments

Oftentimes, attorneys face confusion over which lien is superior when the IRS enters the matter.  This case illustrates some of the complexity involved.

In this case, the individual actually won to some capacity.  Had the IRS not been satisfied, the taxes would have stayed a liability to the taxpayer, resulting in a debt that could not be discharged in bankruptcy since the bank would have kept the rental income.  Since the IRS won, the taxpayer was free to discharge the bank debt in bankruptcy.  This is one time the taxpayer prayed that the IRS would win the case.

By: Basi & Basi at the Center for Financial, Legal and Tax Planning for Transworld M&A Advisors