Discharge of Estate Tax Lien on Sale of Real Estate

A man I’ll call Arthur died with a taxable estate comprised of non-liquid assets. His executors decided to sell his residence to raise funds to pay federal and state estate taxes and to allow his widow to purchase an apartment in an assisted living facility. They found a buyer quickly at a reasonable price, and scheduled the closing as soon as the releases of the federal and state estate tax liens on the residence were received.

We made an application to the Internal Revenue Service to release the federal estate tax lien on Form 4422 (Application for Certificate Discharging Property Subject to Estate Tax Lien), and we expected the so-called “waiver” in about 10 days, as was customary. To the great surprise of the executors and counsel for Arthur’s estate, the IRS refused to issue the waiver—unless the entire net sale proceeds were paid to the IRS for the IRS to hold as an estate tax payment, until the estate tax return (Form 706) is filed and a closing letter issued. As an alternative, the estate’s counsel could hold the net proceeds in escrow, pursuant to an escrow agreement with the IRS. These proceeds could only be remitted to the estate after the IRS issued a closing letter and would have to be used to pay any unpaid estate tax. In short, the estate wouldn’t receive any of these proceeds for many months, if not years, leaving Arthur’s widow potentially homeless, her care/well-being in limbo. 

Unannounced New Procedure

When we contacted the IRS, we were told that no waiver would be issued unless the IRS or the escrow agent received payment of the net proceeds of sale. The IRS explained that this procedure went into effect as of June 1, 2016 and that it hadn’t announced this procedure because this had always been the rule, but the IRS had never enforced the rule until now. The authority for this action is derived from Internal Revenue Code Section 6325 (c), which provides that “[s]ubject to such regulations as the Secretary may prescribe, the Secretary may issue a certificate of discharge of any or all of the property subject to any lien imposed by section 6324 [i.e., lien for estate and gift tax] if the Secretary finds that the liability secured by such lien has been fully satisfied or provided for.” (emphasis added). According to the IRS, this “provided for” language allows the IRS to hold the sale proceeds as a payment on account of the estate tax; and it was now enforcing this provision because it had issued waivers in the past after which the estate tax wasn’t paid.

The new procedure requires the estate to file the Form 4422 with the IRS, and the IRS will then issue a “conditional commitment to discharge certain property from federal estate tax lien.” This document will permit the closing to take place provided: (1) a provisional closing statement is first furnished to the IRS; and (2) the title company remits the gross sale proceeds less approved senior encumbrances and sale expenses (for example, broker fees; recording fees and transfer taxes) to the IRS or the escrow agent. Upon its receipt of the net sale proceeds and the final closing statement, the IRS will issue the waiver. The sale proceeds held by the IRS will accrue interest at the underpayment rate (currently 4 percent) commencing 45 days after the estate tax return is filed. (Some might consider this a benefit – short-term government guaranteed paper paying 4 percent interest).

The IRS informed me that it does have discretion to release the proceeds after the estate tax return is filed and the estate tax is paid in full, if an auditor conducts a preliminary review of the return and determines that the return won’t be audited. This means the estate doesn’t have to wait for a closing letter to receive the funds being held by the IRS.

If the gross estate is below the filing threshold ($5.45 million for individuals dying in 2016) no waiver is necessary. However, if the title company requires a waiver to close, a Form 4422 can be filed with the IRS and the IRS will issue a letter (Letter 1352) stating that there’s no estate tax due and therefore no lien.  

LLC-Owned Real Estate

The good news is that if the real estate or coop apartment is owned by a limited liability company (LLC) and not by the decedent, the LLC can sell the property without the need for a waiver because the estate tax lien is on the LLC membership interest (intangible property) owned by the decedent and not on the real estate. In that case, the sale proceeds don’t have to be remitted to the IRS. However, coop board or mortgage holders don’t always permit placing property in an LLC. 

Hardship Application

I asked the IRS if it would consider a “hardship application” for the estate to retain some of the sale proceeds solely for the purpose of making payment of the state estate tax. As of this date, the IRS National Office has indicated that it wouldn’t consider such a hardship application, but this remains under consideration by the IRS.

Donald A. Hamburg is a partner at Golenbock Eiseman Assor Bell & Peskoe in New York City