Subsequent Federal And State Income Tax Liens: Priority And Redemption

Do federal or state income tax liens trump your Indiana mortgage lien?  Not if you recorded your mortgage first.  In Indiana, first in time is first in right.

Priority of state income tax liens.  Indiana is a “first to file” state.  Under the Indiana recording statute, a mortgage takes priority according to the date of its filing.  Ind. Code § 32-21-4-1(b).  Unlike Indiana’s statutory treatment of delinquent real estate taxes , which are given a super-priority at foreclosure sales, there is no such statutory treatment of state income tax liens.  To my knowledge, Indiana’s tax code is silent with regard to the priority of state income tax liens.  Indeed a state tax lien is akin to a run-of-the-mill judgment lien.  I.C. § 6-8.1-8-2(e)(2) provides that a tax warrant for unpaid income taxes becomes a “judgment” against the person owing the tax and results in the creation of a judgment lien.  In Indiana, judgment liens, which are purely statutory, are subordinate to all prior or equitable liens, including mortgage liens. 

Perfection of state liens.  Logistically, the Department of Revenue will file a “tax warrant” in the county clerk’s office.  The clerk will then automatically enter the tax warrant into the judgment records so as to create the judgment lien on real estate owned by the taxpayer in that particular county.   

Priority of federal income tax lien.  The United States Code contains a provision governing actions affecting real estate on which the IRS has a lien.  28 U.S.C. § 2410(a) states, in pertinent part, that the United States “may be named a party in any civil action . . . (2) to foreclose a mortgage or other lien upon . . . real property on which the [United States] has a . . . lien.”  With regard to the question of priority, § (c) provides:

a judgment or decree in such action or suit shall have the same effect respecting the discharge of the property from the mortgage or other lien held by the United States as may be provided with respect to such matters by the local law of the place where the court is situated.

In other words, state law generally governs, meaning the “first to file” statute, I.C. § 32-21-4-1(b), applies.  See, Religious Order of St. Matthew v. Brennan, 1995 U.S. Dist. LEXIS 8909 (N.D. Ind. 1995) (“in general, the long-established priority rule with respect to federal tax liens is ‘first in time is first in right’”); see also, Citimortgage Inc. v. Sprigler, 209 U.S. Dist. LEXIS 27866 (S.D. Ind. 2009) (summary judgment order identifying second priority federal tax lien vis-à-vis mortgage). 

To perfect its lien, the IRS will record a notice of federal tax lien with the county recorder’s office.

Federal right of redemption.  The unique twist to the federal tax lien is the statutory right of redemption.  Judge Barker identified this in her summary judgment opinion in Citimortgage in which she cited to 28 U.S.C.  § 2410 for the proposition that the United States retains a 120-day right of redemption from the sheriff’s sale.  It’s my understanding that this federal statutory right of redemption trumps Indiana’s redemption statute found at I.C.§ 32-29-7-7, which holds that a right of redemption is terminated immediately upon the foreclosure sale.  Unlike mortgagors and other parties, therefore, Uncle Sam gets to redeem up to four months after the sale.

Federal redemption amount.  28 U.S.C. § 2410(d) describes how to calculate the redemption amount:

In any case in which the United States redeems real property under this section . . . the amount to be paid for such property shall be the sum of-
(1)  the actual amount paid by the purchaser at such sale . . .
(2)  interest on the amount paid . . . at 6 percent per annum from the date of such sale, and 
(3)  the amount (if any) equal to the excess of
(A)  the expenses necessarily incurred in connection with such property, over
(B)  the income from such property plus (to the extent such property is used by the purchaser) a reasonable rental value of such property.

So, in the event of a redemption, the lender would receive cash for the amount of its bid, and then some.

Thanks to our firm’s summer associate, Adam Wanee, for helping with this research.