This article instructs a prospective equity purchase (EP) investor on how to negotiate and execute the release of any judgments or state/federal income tax liens encumbering a homeowner’s residence in foreclosure.
Negotiate a release to create equity
An equity purchase (EP) investor enters into an EP agreement to buy a seller’s residence which is in foreclosure. [See first tuesday Form 156]
After expiration of the seller-in-foreclosure’s five-day cancellation period, escrow is opened and a preliminary title report ordered. The title report discloses an abstract of a money judgment has been recorded against the seller and has attached to the residence, called a judgment lien.
Since the lien was not referenced in the purchase agreement, the down payment may be reduced by the amount of the lien with the responsibility to pay shifted to the EP investor.
The purchase agreement makes it optional for the EP investor to take title subject to the recorded judgment lien rather than having the debt satisfied and the lien released prior to closing. [See first tuesday Form 156 §12.3]
Further, the title insurance company will not write a policy of title insurance without referencing the judgment lien as excluded from coverage unless a partial or full release is obtained prior to closing. The EP investor chooses to have the lien released before closing, rather than opting to leave the lien of record and offset the down payment.
However, the seller-in-foreclosure is uninformed about lien avoidance. Accordingly, the EP investor takes control by contacting the judgment lienholder to negotiate a partial or full release of the lien so the purchase transaction can be closed.
The lienholder initially demands full payment of the debt — why else would he have recorded his lien?
However, leverage exists when negotiating a lien release due to the pending foreclosure of a trust deed loan, as well as the seller-in-foreclosure’s automatic homestead exemption of equity, which are senior to the judgment lien.
The trustee’s foreclosure sale will wipe out the judgment lien. Also, homestead exemptions protect up to $75,000 of the homeowner’s equity, removing it as a source for collecting on the judgment.
The wiped-out lien
Generally, a good bargaining tactic for obtaining a release of a lien from the residence is a combination of:
· a “gentle reminder” that the lien is on the verge of being wiped out by foreclosure;
· a review of the homeowner’s homestead exemption rights against the creditor’s lien;
· an offer to pay a lesser amount in full satisfaction of the debt owed to the lienholder; and
· a partial satisfaction and the execution of a partial release, allowing the abstract to remain of record while releasing the parcel from its lien.
The objective of the negotiations is to give the lienholder sufficient incentive to cooperate and release the property from the lien. The EP investor, as a matter of veracity, is in a better position to deal with the lienholder than the seller-in-foreclosure, who has obviously exhausted his goodwill with the judgment creditor.
A win-win-win situation is created when:
· the lienholder collects a portion of the money owed, which is not enforceable against the residence if a foreclosure wipes out the judgment lien, or an effective homestead recording or exemption exists;
· the seller-in-foreclosure continues with the sale of the residence, avoiding the elimination of his equity by the lender’s foreclosure, and receives the proceeds protected by his homestead exemption for later reinvestment in a replacement residence; and
· the EP investor keeps his purchase agreement alive by negotiating a release of the lien from the property’s title in exchange for a relatively small payment to the lienholder, which is paid out of the seller-in-foreclosure’s proceeds from the sale.
Release of recorded instrument
When the judgment lienholder agrees to release the residence, a signed and notarized release of recorded instrument must be obtained from the lienholder and recorded. All aspects of the paperwork can be handled through escrow, after the EP investor has completed negotiations. [See Form 409 accompanying this article]
The release contains all the information necessary to clear the judgment lien from the residence’s record title.
When the release is notarized and recorded, the judgment lien against the residence is removed, and a policy of title insurance is issued free of the lien.
The FTB as a judgment creditor
A personal income tax lien on the residence by the Franchise Tax Board (FTB) is enforced by the same procedure as any creditor’s judgment lien. The FTB issues a warrant, which has the same force and effect as an abstract of judgment issued by a court. [Calif. Code of Civil Procedure §688.020]
The lien created by recording the warrant attaches in the same priority as would a judgment lien and is subject to the seller-in- foreclosure’s homestead exemption protection of his equity. [CCP §688.030; Government Code §§7170 et seq.]
Unfortunately for the EP investor and the seller-in-foreclosure, no statutory or regulatory authority exists for the FTB to negotiate partial payment of the tax bill in exchange for releasing the residence from the tax lien.
According to California’s “Taxpayer Bill of Rights,” the FTB must release its lien from the residence if the proceeds from the sale would not result in a “reasonable reduction” of the seller-in-foreclosure’s debt. [Calif. Revenue and Taxation Code §21016(a)(3)]
However, no case law exists testing whether the statute may be used as an offensive weapon to quiet title to real estate, eliminating the cloud of a state income tax lien.
Releasing an IRS lien
Consider the EP investor whose preliminary title report reveals the existence of a federal tax lien junior to the trust deed loan which is in foreclosure.
If the residence is sold at a trustee’s sale, the Internal Revenue Service (IRS) may redeem (purchase) the property by later (within 120 days) paying the successful bidder at the trustee’s sale the amount of his bid, plus interest and foreclosure costs. Thus, the equity can be acquired by the IRS after the trustee’s foreclosure sale to satisfy the delinquent income tax. The IRS will later hold its own auction and resell the residence.
If a second trust deed exists on the residence, the IRS will typically wait until the first trust deed lender completes its foreclosure, wiping out the second. The IRS then steps in within 120 days after the trustee’s sale and acquires the residence from the buyer at the trustee’s sale.
The IRS has the authority to negotiate with the equity seller/taxpayer (or the EP investor after closing the EP transaction) to accept partial payment in exchange for releasing the income tax lien when the IRS’ recovery under its lien and redemption and resale would be economically unfeasible. [Internal Revenue Code §6325(b)(2)]
Thus, the release of the IRS tax lien from the property’s title can be negotiated by the EP investor (on behalf of the taxpayer) by using some of the same persuasive techniques used to negotiate a release of a judgment lien with a creditor.
To release the tax lien, the seller-in-foreclosure applies for a discharge of residence from the federal tax lien by submitting a written request to the district director of the IRS. Instructions and format for the request are available in IRS Publication 783 at www.irs.gov. [Revenue Regulations §301.6325-1(b)]
Current IRS policy dictates the IRS, not the seller-in-foreclosure, must receive all or most of any equity remaining in the residence.
Also, the EP investor should consider whether it is more advantageous to take the residence subject to the IRS tax lien, especially if the property is a “fixer-upper.” If little or no equity exists beyond the encumbrances senior to the IRS lien, the EP investor, as the new owner, can negotiate with the IRS for release of the lien in exchange for a small cash payment — frequently less than the IRS would have been willing to accept from the seller-in-foreclosure prior to the EP investor becoming the owner.
However, taking the residence subject to the IRS lien is a calculated risk. The IRS may decide to leave its lien intact on the property, and thus participate in the future property value added by inflation, appreciation or the efforts of the EP investor. [Han v. United States of America (9th Cir. 1991) 944 F2d 526]
The homestead exemption
A homeowner’s equity of up to $75,000 for a head of household is protected by California homestead exemption laws. [CCP 704.710 et seq.]
The homestead protection is automatic when the judgment lienholder (creditor or FTB) attempts to enforce his money judgment by a sheriff’s sale of the homeowner’s residence. The residence cannot be sold by the lienholder when the net proceeds of the sale will be less than the homestead exemption amount.
However, the statutory homestead exemption only applies to court-ordered execution sales to satisfy money judgments against the homeowner and any sale of the home in a bankruptcy proceeding.
While merely a defensive tool for the homeowner, the automatic homestead exemption becomes a powerful offensive tool in a bankruptcy proceeding. Through bankruptcy proceedings, the homeowner can clear his title of judgment and state tax liens which impair the value of his homestead. [In re Herman (9th Cir. BAP 1990) 120 BR 127; 11 United States Code §522(f)].
However, the automatic homestead exemption is not enforceable against an IRS tax lien in bankruptcy. [U.S. v. Heffron (9th Cir. 1947) 158 F2d 657; 11 USC §545]
Alternatively, the homeowner may have recorded his declaration of homestead prior to the date the judgment lien was recorded. If the recorded homestead is senior to the judgment creditor’s or FTB’s lien and the net proceeds of a voluntary sale of the residence will be less than the homestead amount, the owner can quiet title the property from the effect of the judgment or FTB tax lien.
However, like the automatic homestead exemption, the recorded homestead has no priority over an IRS tax lien. Thus, the IRS can still force the sale of the residence under its tax lien. [U.S. v. Rodgers (1983) 461 US 677]
In practice, the release of an IRS lien is always negotiated based on whether or not it has recorded priority over voluntary encumbrances and judgment liens on the residence — the homestead having no effect on the lien rights of the IRS.
Whether it is by an automatic exemption or recorded declaration, the homestead is a good bargaining chip to be used to induce judgment lienholders and the FTB to voluntarily release their lien from the title to the residence. The effects of foreclosure, a bankruptcy or quiet title action to enforce the homestead exemption and clear title gives the lienholder incentive to negotiate the release.
Preparing the Release of Recorded Instrument
Check and enter only the items to be included as provisions in the release.
§1. Enter the name of the document which created the lien on the property, e.g., abstract of money judgment.
§2. Enter the date the document creating the lien was prepared, and the date and identification of its recording.
§3. If the document is a release of an abstract of money judgment, the lienholder must check the box and:
· enter the name of the court which entered the judgment;
· enter the date of the judgment and the date it was renewed, if any;
· enter the cause of action in the case, e.g., breach of contract, negligent misrepresentation, unlawful detainer, etc.; and
· enter the docket number of the case. [CCP §697.370]
§4. Enter the names of the lienholder and seller. [Gov C §27288.1(b)]
§5. Check the box indicating whether the release is:
5.1 a blanket release of all recorded interests in real estate in the county. If all property is released, again enter the name of the seller-in-foreclosure — identifying him as the owner, all of whose property is being released from the judgment lien; or
5.2 only for a specific property, a partial release. If only a specific property is released, enter the legal description of the property.
The lienholder unilaterally executes the release by signing it and dating his signature.
Notarize the release for recording — recording clears the seller-in-foreclosure’s title of the lien. [Gov C §27287]