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Mortgage Lender Has Priority Over IRS When Interest Was Acquired First - Bloomfield State Bank v. U.S.

July 13, 2011

As San Bernardino County foreclosure defense lawyers, we handle a lot of bankruptcies that are explicit attempts to stop a foreclosure. As a result, we know that the IRS almost always gets its money in bankruptcy court -- debts to the agency are rarely dischargeable. So we were very interested in a recent Seventh U.S. Circuit Court of Appeals decision turning that principle on its head by assigning rental income from a debtor's property to the mortgage lender with the primary lien, even though the IRS also claimed it. In Bloomfield State Bank v. United States, the Seventh Circuit ruled that under federal law, the mortgage holder has priority because its interest in the property existed before the IRS filed its lien.

The underlying mortgage was issued to an Indiana resident in 2004; the default happened in 2007. The mortgage contract secured the mortgage with the real estate and other interests, including an interest in rent derived from the property. The bank successfully asked the court to appoint a receiver to administer the property; that receiver collected rents totaling $82,675. The IRS filed its tax lien sometime around or after default, and argued to the bank that it should have priority over any rents collected after its lien was in place. The bank sued for a declaratory judgment saying the opposite, and a federal court granted summary judgment to the IRS. This appeal followed.

The case turns on 26 USC 6323, the Seventh said, which says property interests like the bank's can take priority if "the property is in existence and the interest has been protected under local law against a subsequent judgment lien arising out of an unsecured obligation." For the Seventh, the issue was whether the property was "in existence," which in turns gave rise to a dispute between the parties over whether the property at issue was the home or the rental proceeds, which did not exist when the IRS filed its lien. The district court found that the rental proceeds were in dispute, but the Seventh reversed. The property referred to by the statute is the property that is "a source of value for repaying the loan in the event of default"; not the money received by exploiting that source of value. This, the court reversed and directed the trial court to enter judgment in favor of the bank.

Our Long Beach foreclosure defense attorneys are pleased to see the court giving clarity to a small but important matter involving the IRS, because the IRS is a muscular creditor in many personal bankruptcies. The vast majority of bankruptcies involve different interests competing for the same limited money. Competition between two powerful creditors, as here, can create delays to ending the bankruptcy -- ultimately hurting the debtor's efforts to complete a bankruptcy and start rebuilding. When it leaves either creditor unsatisfied, it can also create further problems for the debtor because he or she may have to pay the balance owed. To get the best possible chance of a smooth and effective bankruptcy, you should always talk to a Santa Ana foreclosure defense lawyer as early as possible in your case.

If your home is in default or foreclosure, or you think it will be soon, and you'd like to fight back, call Howard Law PC to see how we can help. For a free consultation, you can reach us toll-free at 1-800-872-5925 or send us a message online.

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