November 2002
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November 2002 |
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A PUBLICATION OR THE TITLE COMPANY OF NORTH CAROLINA |
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FEDERAL TAX LIENS vs. PURCHASE MONEY DEEDS OF TRUST — AN UPDATE 1.
Background When the U.S. Supreme Court decided U.S. v. Craft, 535 U.S. __ (U.S. Supreme Court April 18, 2002), the case involving the
attachment of a federal tax lien filed against one spouse to entireties
property (see our newsletters of April 2002 and June 2002 for a discussion
of various aspects of the case), we stated that U.S. v. Craft would not cause us to change our application of the
“purchase money rule” or “or instantaneous seisin rule” to the
priority contest between a purchase money deed of trust and a previously
docketed federal tax lien. The fact pattern that sets up application of the rule
when a judgment, mechanics’ lien, or federal tax lien is involved as the
prior lien (at least prior to U.S.
v. Craft) is as follows: EXAMPLE: On January 15, 2002, a federal tax lien is
docketed against Jones. On September 10, 2002, Jones buys Lot 5 with a
house on it. On September 10, 2002, at 10:00am, the deed to Jones is
recorded. Virtually simultaneously, on September 10, 2002 at 10:01am, a
deed of trust is given by Jones to the trustee for a bank and is recorded.
All loan proceeds are used to facilitate the purchase of the property. The
result: instead of the federal tax lien having priority over the deed of
trust because the federal tax lien was filed and docketed before the deed
of trust was recorded, the “purchase money rule” or “instantaneous
seisin rule” results in the deed of trust having priority over the
federal tax lien. The basic rule is quoted in Hetrick and McLaughlin, Webster’s
Real Estate Law In North Carolina, 20-7(b): With respect to the priority of docketed judgments
against other lien claimants, a special rule applies where the contest is
between a prior judgment creditor and a vendor who has conveyed real
property to the judgment debtor subsequent to the docketing of the
judgment against the judgment debtor, and has taken a purchase money
mortgage or deed of trust to secure the purchase money. In such case,
notwithstanding the priority of docketing the judgment, it has been held
that the liens of judgment creditors do not attach to such after acquired
real property under these circumstances. (Citations omitted.) The Supreme
Court of North Carolina has said: “The title vests, but does not rest;
but ‘like the borealis race, that flits ere you can point the
place.’” (Citations omitted.) The mortgage or deed of trust for the
purchase money will prevail over previously docketed judgments whether
made to the vendor of the real property or to a third person. (Citations
omitted.) For this rule, several cases are cited as follows: Smith
Builders Supply, Inc. v. Rivenbark, 231 N.C. 213, 56 S.E.2d 431
(1949); Virginia-Carolina Chem. Co.
v. Walston, 187 N.C. 817, 123 S.E. 196 (1924); Humphrey
Bros. v. Buell-Crocker Lumber Co., 174 N.C. 514, 93 S.E. 971 (1917); Bunting
v. Jones, 78 N.C. 242 (1878); Smith
Builders Supply, Inc. v. Rivenbark, 231 N.C. 213, 56 S.E.2d 431
(1949); Savings Bank & Trust Co.
v. Brock, 196 N.C. 24, 144 S.E. 365 (1928); Weil
v. Casey, 125 N.C. 356, 34 S.E. 506 (1899); Moring
v. Dickerson, 85 N.C. 466 (1881); Pegram-West,
Inc. v. Hiatt Homes, Inc., 12 N.C. App. 519, 184 S.E.2d 65 (1971). Also, see E. Urban and G. Whitney, North
Carolina Real Estate, 21-72 (Harrison Co. 1996). As these authors
point out, (1) in Slate v. Marion,
104 N.C. App. 132, 408 S.E.2d 189 (1991), the rule did not apply in an
unusual set of facts where Daniel acquired title but never actually
purchased the land and so the Shropshires’ deed of trust was not a
purchase money deed of trust; (2) an eleven day delay between the time the
deed and deed of trust were recorded prevented the application of the rule
in Pegram-West, Inc. v. Hiatt Homes,
Inc., 12 N.C. App.519, 184 S.E.2d 65 (1971); (3) in Dalton
Moran Shook Inc. v. P.H. Development Co., 113 N.C. App. 707, 440
S.E.2d 585 (1994), the Court of Appeals held that the purchase money
priority or instantaneous seisin rule only applied to those loan proceeds
used to purchase the property and not the proceeds used for construction
advances; and (4) in Carolina
Builders Corp. v. Howard Veasey Homes Inc., 72 N.C. App. 224, 324
S.E.2d 626, discr. rev. den., 313 N.C. 597, 330 S.E.2d. 606 (1985), the
court held that the rule did not apply where the deed to the purchaser was
recorded, then an intervening construction loan deed of trust was recorded
and then the purchase money instrument was recorded. The intervening
construction loan deed of trust precluded the application of the special
rule. The “eleven day gap” rule in Pegram-West
discussed above was criticized as incorrect in E. Urban, North Carolina Real Property Mechanics’ Liens, Future Advances, and
Equity Lines—Including Title Insurance, 8-3 (Harrison Co. 2d ed.
1998) since, as among the “mortgagor’s grantor”, the “mortgagor”
and the “mortgagee” in such a situation, recordation is unnecessary as
to passage of title and creation of interests. 2.
Analysis of Federal Law in Addition to U.S.
v. Craft However, in view of U.S.
v. Craft, supra, and other cases discussed below and brought to our
attention after our above cited newsletters, we wonder how long the
“purchase money rule” or “instantaneous seisin rule” will exist.
That is, we are not sure that, given the opportunity, the U.S. Supreme
Court will be any more impressed with state law borealis races than NASCAR
races. The first thing to consider is the helpful I.R.S.
Ruling 68-57. It states as follows: The Federal Tax Lien Act of 1966, P.L. 89-719, C.B.
1966-2, 623, does not refer to a purchase money security interest or
mortgage. However, the General Explanation of the Act, as set forth in
House of Representatives Report No. 1884, C.B. 1966-2, at page 817, states
as follows: Although
so-called purchase money mortgages are not specifically referred to under
present law, it has generally been held that these interests are protected
whenever they arise. This is based upon the concept that the taxpayer has
acquired property or a right to property only to the extent that the value
of the whole property or right exceeds the amount of the purchase money
mortgage. This concept is not affected by the bill. In
view of the legislative history of the Federal Tax Lien Act of 1966, the
Internal Revenue Service will consider that a purchase money security
interest or mortgage valid under local law is protected even though it may
arise after a notice of Federal tax lien has been filed. However, several cases make us wonder what
the Supreme Court will do when confronted with a federal tax lien and a
purchase money deed of trust. U.S. v.
McDermott, 113 S.Ct. 1526 (1993), involved the following facts: (1)
12-9-86: U.S. makes a tax assessment against taxpayers. (As
between U.S. and taxpayers, this creates a lien on property now owned
or hereafter acquired.) (2) 7-6-87:
Bank dockets a state court judgment against taxpayers. (Under state
law, this gives the bank a lien on all real property now owned or
hereafter acquired.) (3) 9-9-87:
U.S. files and dockets a federal tax lien for the tax. (4) 9-23-87:
Taxpayers acquire title
to the real property in question. Of course, the bank would have won if the
facts had been different as follows: (1) 9-23-87:
Taxpayers acquire title.(2) 9-25-87:
Bank dockets a judgment against taxpayers. (3) 10-3-87:
U.S. files and dockets a federal tax lien against taxpayers. 26
U.S.C. Sec. 6323(a). However, on the facts in McDermott,
the holding was as follows: The bank’s judgment lien was not
“choate” (final) until the taxpayers acquired title on 9-23-87. The
U.S.’s federal tax lien was not choate until then. So neither lien
“attached” until the taxpayers acquired title. But due to 26 U.S.C.
Sec. 6323(a), since the U.S. filed and docketed on 9-9-87 before
the taxpayers acquired title, the U.S. has priority over the bank’s
judgment even though bank docketed before the U.S. McDermott
is not a holding concerning, and does not contain dicta
about, a purchase money deed of trust—expressly. Can McDermott
be distinguished from a purchase money deed of trust situation? That is
hard to do. Factually, here is what would present itself for
consideration: (1) 9-9-87: Federal
tax lien is docketed against the taxpayers. (2) 9-23-87:
Taxpayers acquire title to the real property and give a deed of
trust to a trustee for the lender, which is a purchase money deed of
trust. The deed and deed of trust are recorded simultaneously. The only difference between this and the McDermott
facts is that here, the deed of trust (lien) is recorded after the deed
and secures purchase money. Cited North Carolina law discussed above seems
to contain a nice legal fiction that is not exactly true. Instead, title
vests, a prior federal tax lien can attach and then the deed of trust,
recorded second, would be inferior. This could be true in view of 26 U.S.C.
Sec. 6323(a) and the thinking in McDermott. In Slodnov v.
United States, 436 U.S. 238, 98 S.Ct. 1778 (1978), the following
statement at footnote 23 was made: FN23. Decisional law has long established that
a purchase-money mortgagee’s interest in the mortgaged property is
superior to antecedent liens prior in time, see United
States v. New Orleans R. Co., 12 Wall. 362, 20 L.Ed. 434 (1871), and,
therefore, a federal tax lien is subordinate to a purchase-money
mortgagee’s interest notwithstanding that the agreement is made and the
security interest arises after notice of the tax lien. The purchase-money
mortgage priority is based upon recognition that the mortgagee’s
interest merely reflects his contribution of property to the taxpayer’s
estate and therefore does not prejudice creditors who are prior in time. In enacting the Federal Tax Lien Act of 1966,
Congress intended to preserve this priority, H.R.Rep. No. 1884, 89th
Cong., 2d Sess., 4 (1966), and the IRS has since formally accepted that
position. Rev.Rul.68-57, 68-1 Cum.Bull. 553; see also IRS General
Counsel’s Op.No. 13-60, 7 CCH 1961 Stand. Fed.Tax Rep. 6307 (1960). In Burrus v.
Oklahoma Tax Commission (CA. 10th. 1995), a state tax
warrant was recorded ahead of the federal tax lien. Pursuant to Oklahoma
homestead law, the state was precluded from foreclosing its lien. The
court held that the state tax lien had priority over the federal tax lien
and the fact that the homestead law prevented foreclosure did not mean
that the state tax lien was not “choate.” The court cited McDermott
and U.S. v. Rogers, 461 U.S. 677 (1983) (the Burrus court saying “The Supreme Court has endorsed distinction
between foreclosure on and attachment of a tax lien in the homestead
context.”) Burrus, while
interesting, is not dispositive regarding a purchase money deed of trust. 3.
Conclusion When we stated that U.S.
v. Craft would not cause us to change our position on the priority of
a purchase money deed of trust over a prior docketed Federal tax lien (see
1. Background above), we felt
that U.S. v. Craft was poorly
reasoned—and was “good law” only because the U.S. Supreme Court said
so, however erroneously—but there was some risk, which we were willing
to take, that U.S. v. Craft
might cause the U.S. Supreme Court to alter the “purchase money rule”
or “instantaneous seisin rule.” It would seem that U.S. v. McDermott, discussed above, could be used to change the
rule. Frankly, changing the rule would be easier to understand than the
court’s off the wall holding in U.S.
v. Craft. There is quite a bit in 26 U.S.C. Sec. 6323 regarding
priority to add to U.S. v. McDermott
to justify such a change. 26 U.S.C. Sec. 6323(a) literally states the
following: The lien imposed by section 6321 shall not be valid
as against any purchaser, holder of a security interest, mechanic’s
lienor, or judgment lien creditor until notice thereof which meets the
requirements of subsection (f) has been filed by the Secretary. 26 U.S.C. Sec. 6323(b), entitled “Protection for
certain interests even though notice filed,” contains no protection for
a purchase money instrument. Nor does the rest of 26 U.S.C. Sec. 6323. Old
Republic’s Home Office Legal Department says that since the above cited
revenue ruling has not been withdrawn in the face of U.S.
v. McDermott “and the courts seem to realize that a purchase money
mortgage is a different beast than a garden variety state court
judgment,” Old Republic will continue to follow the “purchase money
rule” or the “instantaneous seisin rule” notwithstanding current
above cited Supreme Court cases. Therefore, The Title Company of North
Carolina will continue to rely upon the rule. EQUITABLE DISTRIBUTION AND ATTACHMENT
OF LIENS In Branch Bank
and Trust Co. v. Wright, 74 N.C. App. 550, 328 S.E. 2d 840 (1985),
husband (H) and wife (W) owned real
property as tenants by the entirety.
H borrowed money and
executed a deed of trust on the real property.
The deed of trust was recorded.
H and W got a divorce, which converted the tenancy by the entirety to a
tenancy in common. Then, W
received the real property in equitable distribution.
The court held that upon divorce, H
and W held title as tenants in
common, the deed of trust given by H
attached to H’s one-half
undivided interest in the real property and W
took the real property subject to the deed of trust encumbering H’s one-half undivided interest.
This rule has also been applied to a judgment lien.
Union Grove Milling &
Mfg. Co. v. Faw, 103 N.C. App. 166, 404 S.E. 2d 508 (1991). It would seem that this result adverse to W
could be averted by W using G.S.
50-20(h), which states in part that: If either party claims that any real property is
marital property or divisible property, that party may cause a notice of
lis pendens to be recorded pursuant to Article 11 of Chapter 1 of the
General Statutes. Any person
whose conveyance or encumbrance is recorded or whose interest is obtained by descent, prior
to the filling of the lis pendens, shall take the real property free of
any claim resulting from the equitable distribution proceeding.
(Emphasis added.) If a G.S. 50-20(h) lis pendens is properly recorded
by W before the judgment of
absolute divorce is filed, it seems possible that W would take title free and clear of the deed of trust given by H
or a lien filed only against H.
However, G.S. 50-20(h) is not artfully drawn and could be clearer,
since it presently sets out a rule referring to a person whose conveyance
or encumbrance is recorded
before the lis pendens is filed. Of
course, if H gives a deed to W and that deed is recorded before
the judgment of absolute divorce is entered, W could avoid the attachment of such a deed of trust or lien.
Careful legal counsel by W’s
attorney in preparation for the entry of a judgment of absolute divorce
can avoid problems for W. It has been mentioned that Branch
Bank and Trust Co. v. Wright would be incorrect today in view of G.S.
39-13.6(a) which provides: A husband and wife shall have an equal right to the
control, use, possession, rents, income, and profits of real property held
by them in tenancy by the entirety. Neither
spouse may bargain, sell, lease, mortgage, transfer, convey or in any
manner encumber any property so held
without the written joinder of the other spouse.
This section shall not be construed to require the spouse’s
joinder where a different provision is made under G.S. 39-13, G.S.
39-13.3, G.S. 39-13.4, or G.S. 52-10.
(Emphasis added.) However, it is probable that the language of G.S.
39-13.6(a) emphasized above means only that one spouse cannot convey or
encumber “the property so held.”
That is, one spouse cannot convey or encumber the entire
interest in the tenancy by the entirety.
And, of course, in a fact situation such as in the above cited
cases, the tenancy by the entirety is not
conveyed or encumbered during
the existence of the tenancy by the entirety.
Instead, the encumbrance is created
against a one-half interest in a tenancy in common only after H and W get an absolute
divorce. The encumbrance was
merely recorded before the
absolute divorce. See, generally, the articles in 64 N.C.L. Rev. 1471 (1986) and 65 N.C.L. Rev. 1195 (1987) which cast doubt upon the result of the above cited case law rule in view of G.S. 39-13.6(a). |