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Transferring Property Owned by Taxpayer With Unpaid Taxes
In United States v. Urioste, No. 4:15-CV-1787-VEH (N.D. Ala 2017), the court considered the situation where a business purchased and improved real estate that was encumbered by an IRS tax lien. The case highlights why it can be more advantageous to structure a transaction as a loan rather than a purchase when dealing with property owned by a taxpayer who has unpaid taxes.
Facts & Procedural History
The facts and procedural history are as follows:
- The case relates to the tax liabilities of Mr. Urioste (the “Taxpayer”), who was deceased, and his single member LLC.
- On April 21, 2006, the Taxpayer purchased real property that was the subject of the court case. The property was purchased using proceeds from a bank mortgage and the bank filed its mortgage the same day the real estate was purchased.
- On April 25, 2006, the Taxpayer’s son formed an LLC.
- On May 22, 2006, the IRS filed a notice of Federal tax lien against the Taxpayer.
- On November 8, 2006, the Taxpayer requested an installment agreement with the IRS.
- On November 13, 2006, the Taxpayer transferred the property to his son’s newly-formed LLC. The deed transferring the property excepted the IRS’s lien. The only consideration for the transfer was the son’s LLC assumed the bank’s mortgage on the property.
- On November 2, 2007, the IRS rejected the Taxpayer’s installment agreement request.
- On May 19, 2011, the son’s LLC paid off the bank’s mortgage on the property.
- The son’s LLC had made $140,000 of improvements to the property.
- On October 13, 2015, the government brought suit against the Taxpayer’s personal representatives and the son’s LLC to seize the property.
- Neither the son nor the son’s LLC were aware of the IRS lien notice prior to the time the government brought suit.
In the case, the court looked to state law (i.e., Alabama law) to determine what rights the parties had to the property. The Taxpayer cited several judicial doctrines to argue that it had a superior right to the property than the IRS did.
The doctrine of equitable subrogation applies where one party advances funds to pays off the debt secured by another lien. This doctrine allows the new lender to step into the shoes of the prior lender and avoid another lien that would have priority. The doctrine does not apply if the new lender is aware of or should be aware of the other lien that would have priority.
So in this case, the Taxpayer argued that the son’s LLC stepped into the shoes of the bank, whose mortgage had priority over the IRS’s tax lien, and the IRS was not entitled to enforce its inferior lien.
The court did not agree, as it concluded that the son’s LLC was not a lender but rather a purchaser.
Unjust enrichment is an equitable argument whereby one party asserts that it is unfair for another party to benefit given the facts. In this case, the Taxpayer argued that it would be unfair for the government to benefit from the expenses the son’s LLC incurred in improving the property. The Taxpayer asked the court to find that there was an equitable lien, with priority, in the son’s LLC’s favor equal to the amount of the improvements.
The court considered Alabama law, which essentially says that unjust enrichment can only be invoked where there was some wrongdoing by the other party or some mistake. The court concluded that the government did not do anything wrong and that the expenditures were not made by mistake, but rather, they were made in furtherance of the son’s LLC’s business operations.
Marshaling of the Assets
The marshaling of the assets is another equitable argument. It applies where a debtor has two or more creditors and assets, and says that the creditor with priority cannot choose the asset that will result in the other creditor not being entitled to anything.
In this case, the Taxpayer argued that the government should foreclose on the Taxpayer’s other property first, before it forecloses on the property at issue in the case.
The court concluded that the son’s LLC was not a creditor, but rather a party that acquired the property. The Taxpayer argued that it was an equitable creditor because it paid off the bank mortgage. The court did not agree, and noted that prior courts have refused to require the government to marshall the assets when satisfying IRS tax liens.
While the Taxpayer was not successful in this case, the arguments show the distinction between being a lender and a purchaser when it comes to IRS liens. The parties are free to structure their affairs as they see fit (absent fraudulent transfers or other transfers for less than fair market value), which should be considered when dealing with property that could be subject to an IRS tax lien.