Author K. Slaughter Found Liable for Employment Taxes, But Not Penalties, in Tax Court Opinion
US Supreme Court Holds States Cannot Tax Out-of-State Trust Income if Undistributed to In-State Beneficiaries

Can an Unrecorded Deed Defeat an IRS Federal Tax Lien?

Can an Unrecorded Deed Defeat an IRS Federal Tax Lien in California?

Yes, an unrecorded deed for California real property can defeat a later-arising IRS federal tax lien against the prior owner. However, under certain circumstances, the IRS can follow the property for collection purposes if the transfer was not bona fide (e.g. the recipient is a mere nominee) or was done without an exchange of reasonable consideration when the transferor knew or should have known about the tax liability (e.g., a fraudulent conveyance).

A federal tax lien statutorily arises against all property and rights to property owned by the taxpayers as of the assessment date under 26 U.S.C. §§ 6321 and 6322 when notice and demand for payment is made (e.g., a bill is issued) and the tax is not immediately paid.  Under 26 U.S.C. § 6323(a) and (f), the lien imposed by Section 6321 is not valid against any purchaser until the notice of federal tax lien is filed in the county where the real property sits.  In other words, a federal tax lien only affects a purchaser who acquires the real property after the notice of federal tax lien has been recorded.

Furthermore, because the statutory language of 26 U.S.C. § 6321 only provides for a lien upon “all property and rights to property, whether real or personal, belonging to [the person liable to pay any tax],” the IRS only steps into the shoes of the taxpayer.  This means that the IRS has no greater rights to real property following the assessment than the liable taxpayer had as of that date.  When the taxpayer is divested of his interest by a transfer (whether by deed or by order-of-court, including a divorce judgment or decree) and has no further right to the property, the IRS’s subsequent lien will give rise to no right to the property.  See United States v. Gibbons, 71 F.3d 1496, 1501 (10th Cir. 1995); Thomson v. United States, 66 F.3d 160 (8th Cir. 1995); United States v. V & E Engineering & Construction Co., 819 F.2d 331 (1st Cir. 1987); Filicetti v. United States, Case No. 1:10-cv-00595-EJL (Dist. Idaho, Memorandum Decision and Order dated Feb. 23, 2012).  Essentially, if the taxpayer has no interest, the IRS has no interest.

With respect to the effect of failing to record a grant deed, California Civil Code Section 1214 provides:

Every conveyance of real property or an estate for years therein, other than a lease for a term not exceeding one year, is void as against any subsequent purchaser or mortgagee of the same property, or any part thereof, in good faith and for a valuable consideration, whose conveyance is first duly recorded, and as against any judgment affecting the title, unless the conveyance shall have been duly recorded prior to the record of notice of action.

Per this section, an unrecorded deed would only be void against purchasers, mortgagees, judgment creditors.  A tax lien, however, is a statutory lien under 26 U.S.C. § 6321 and the IRS has no judgment, is not a mortgagee, and is not a purchaser.  See United States v. Gilbert, 345 U.S. 361, 362-365 (1953). In United States v. Gilbert, the U.S. Supreme Court held that a city tax lien was not a “judgment creditor” even though the state statute described the tax lien as “in the nature of a judgment” because a judgment requires a court order. Id. Accordingly, a statutory tax lien is not entitled to greater rights under California law than what is accorded by federal law, merely stepping into the taxpayer’s shoes – meaning that a later-arising tax lien gives the IRS no interest where the taxpayer’s interest was already fully transferred away, whether the transfer is recorded or not.  See V & E  Engineering & Construction Co., 819 F.3d at 334 (Attachment 8) (distinguishing that case from two reaching a different result on grounds that the Texas statute in the distinguished cases rendered the unrecorded sale “void as to all creditors” where the Puerto Rico recording statute in V & E limited invalidity to good faith purchasers, and further noting that the tax lien failed to attach regardless of that language because the seller/taxpayer was still bound by the transfer).

However, where the transfer is not bona fide or was done for less than reasonably adequate consideration while the tax was known or should have been known to be due, there remains a possibility that the IRS can reach the property. Failure to promptly record a deed could be seen as evidence supporting a determination that the transfer was not in good faith and can be avoided. See Leeds LP v. United States, 807 F. Supp. 2d 946 (S.D. Cal. 2011).

Federal tax liens attach to property held by a taxpayer’s nominee or alter ego, and such property is subject to the collection of the taxpayer’s tax liability.  See G.M. Leasing Corp. v. United States, 429 U.S. 338, 350-351, 97 S. Ct. 619, 50 L.Ed.2d 530 (1977) (the IRS “could properly regard petitioner’s assets as [taxpayer’s] property subject to the lien under § 6321”); Wolfe v. United States, 798 F.2d 1241, 1244 n. 3, amended 806 F.2d 1410 (9th Cir. 1986).  Property is held by a nominee when someone other than the taxpayer has legal title but, in substance, the taxpayer enjoys the benefits of ownership.  Oxford Capital Corp. v. United States, 211 F.3d 280, 284 (5th Cir. 2000); Holman v. United States, 505 F.3d 1060, 1065 (10th Cir. 2007). 

California has enacted legislation in accord with the Uniform Voidable Transactions Act, which generally allows creditors, including the government, to avoid a transfer if the transfer was either actually fraudulent with the intent to evade collection by the creditor or if the transferor was insolvent at the time of the transfer and knew or should have known the transfer would render him unable to pay the debt. This statutory scheme, encompassed in Cal. Civ. Code Section 3439 et seq., has lengthy definitions and factors that should be read in full for a more detailed understanding.

The above is not intended to be legal advice. Collections and laws are complicated and the general rules sometimes do not apply or may have exceptions. For your specific situation, an attorney should be consulted.

Posted by Daniel Layton on 06/14/2019.