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Module 9 · Legal & Risk

The IRS 120-Day Right to Redeem After Foreclosure

When a junior federal tax lien is wiped out by foreclosure, the IRS can still buy the property back within 120 days. How it works.

5 min read · Lesson 9.15

A first trust deed holder starts a trustee’s foreclosure on the real estate securing his note, and schedules and records a notice of trustee’s sale. An investor in foreclosure properties hears about the sale and wants to bid, because the amount due on the first makes the property look like a bargain.

Checking title, the investor’s broker finds a federal tax lien, junior to the first trust deed and several other liens. The broker warns that the IRS, unlike every other lienholder, has a right to redeem the property after the sale if the investor wins the bidding and receives a trustee’s deed. Is the broker right?

Why the IRS can redeem after the sale

Yes. The trustee’s sale wipes out the junior federal tax lien, but the IRS has the right to redeem the property within 120 days after the sale and take ownership from whoever received the trustee’s deed. [28 USC §2410(c)]

When a junior federal tax lien has been eliminated by a judicial or nonjudicial foreclosure sale on a senior trust deed, the IRS has 120 days after the sale to redeem. [IRC §7425(d)(1)]

If the tax lien is recorded after a judicial foreclosure action is filed, the lien is eliminated whether or not the IRS was named and served, and it no longer affects title once the foreclosure is complete. [IRC §7425(a)(2)]

Even though the junior tax lien no longer encumbers title, the IRS may claim excess sale proceeds any time before they are distributed. Its claim on surplus from an overbid has the same priority as the tax lien. Applying surplus funds to the tax lien does not affect the IRS’s 120-day redemption right. [IRC §7425(a)(2)]

What the IRS must pay to redeem

To redeem, the IRS pays the buyer at the trustee’s sale:

  • The price paid at the foreclosure sale, plus 6% interest from the date of sale. [28 USC §2410(d)(1),(2)]
  • Any amounts the buyer paid on liens senior to the foreclosing lender’s position. [IRC §6323(e)(6); Rev. Regs. §301.7425-4(b)(1)(iv); Little v. U.S. (9th Cir. 1986) 794 F2d 484]
  • The buyer’s expenses connected with owning the property, minus the property’s income, or its fair rental value if the buyer lives there. [28 USC §2410(d)(3); IRC §6323(e)]

Worked example: a lender’s $50,000 credit bid

A lender forecloses a trust deed. The remaining principal, interest and advances on the note, plus the lender’s foreclosure costs, total $100,000. The lender takes the property on a credit bid of $50,000 at the trustee’s sale.

ItemAmount
Total owed to the foreclosing lender$100,000
Lender’s credit bid at the trustee’s sale$50,000
IRS must pay within 120 days to redeem$100,000 plus 6% interest

Despite the underbid, the IRS must pay the full $100,000 plus 6% to redeem.

If the IRS doesn’t tender payment to the trustee’s sale buyer within the 120 days, the buyer can cancel the tax lien through a quiet title action, if title insurers won’t issue a policy without listing the lien as an exclusion. [Miners Savings Bank of Pittston, PA v. U.S. (1953) 110 F.Supp 563]

Paying off a federal tax lien

A lienholder junior to the federal tax lien, the buyer at the trustee’s sale, or an interested third party such as a title insurer can pay off the tax lien to protect their interest or equity in the foreclosed property.

A title company that missed the lien’s recording, and had to clear the lien under a policy it issued, will often take an assignment of the IRS lien when it pays it off. However, the IRS can refuse payment of its lien during the 120 days after the sale and take title to the property by redemption instead.

When the tax lien survives the foreclosure

A federal tax lien stays on title after a foreclosure sale if:

  • The tax lien was recorded more than 30 days before the sale date and the IRS did not receive proper notice of the sale [Simon v. U.S. (9th Cir. 1985) 756 F2d 696]; or
  • The tax lien was recorded before the judicial foreclosure action was filed, and the IRS was not named and served with the summons and complaint. [IRC §7425(a)(1)]

Adapted from an article in first tuesday.

Key takeaways

  • Foreclosure wipes out a junior tax lien
  • The IRS still has 120 days to redeem
  • Redemption price includes 6% interest
  • Improper notice lets the lien survive

Try it yourself

An investor buys at a trustee’s sale for $80,000 and also pays off a $5,000 senior lien. If the IRS redeems, what must it pay?

Show answer

The $80,000 sale price plus 6% interest from the date of sale, plus the $5,000 paid on the senior lien, plus the investor’s ownership expenses minus any income or rental value from the property.

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