For the latest on this see my follow-up post
When I was a kid, my father worked on Wall Street. He was a Senior Order Clerk. I'm not sure whether his job still exists. It was not particularly lucrative, but I got these insights into high finance through the jokes that he used to tell me. Most of them I didn't "get" until I was in my thirties. One of my favorites is the little ditty "He who sells what isn't hissen, buys it back or goes to prison." That was about short sales as the term relates to securities.
The term means something else in real estate. If a property has a fair market value lesser than the mortgage, the secured party might let the property be sold for an amount lesser than the mortgage. This avoids the need for foreclosure. The owner may or may not remain liable for the balance, the discharge of which may or may not be a taxable event. Such is not the topic of this post.
When I was buying a condo, I found that buying property on a short sale tended to be fraught with delay. You would think that the pressure to sell would create pressure to move things along, but the pressure is not sufficient to overcome bureaucratic inertia. Not surprisingly people who have trouble paying their mortgages frequently have trouble paying their taxes. So it is not unusual for a property with an upside down mortgage to have IRS liens against it. In order for the property to transfer the IRS must release its lien.
Typically the first mortgage will have been in place before the IRS filed its liens. So the value of the lien is the lesser of the tax obligation or the taxpayers equity in the property. In the case of a short sale the latter amount is 0. So the IRS should release its worthless lien and let life go on. That is not what has happened though. Even though the IRS is behind the first mortgage, they are, or at least, believe they are ahead of everybody else :
Applications for Discharge Which Include Requests for Payment of Real Estate Transfer Tax....In cases where a filed notice of federal tax lien has perfected the interest of the United States in such property, the Service is asked to issue a certificate of discharge of federal tax lien to allow payment of the state's claim at closing. It is the Service's position that such taxes have no priority status under I.R.C. §6323(b)(6) against the filed notice of federal tax lien. ... Priority of the federal tax lien is defined exclusively in I.R.C. §6323. Under no circumstances will a discharge of federal tax lien be issued for less than the full value of the Service's claim on the equity in the subject property. The transfer tax will not be accorded priority status or treated as an expense of sale. Applications that include such provisions will be rejected.
Under this interpretation, the taxpayer/property owner has to come up with the transfer taxes in order to move the transaction on.
PMTA 2010-058 finds the above interpretation to be erroneous:
We disagree with the conclusion that the designation by the senior lienholder of some of its proceeds to be used to pay real estate transfer taxes in connection with short sales of real property somehow creates an equity interest in the property on the part of the taxpayer. Rather, these are expenses that the senior lienholder agrees to carve out of its priority lien claim as a matter of business prudence in order to facilitate the sale. Because this does not create an equity interest on behalf of the taxpayer that is subject to the federal tax lien, the authority of the Service to issue a certificate of discharge is under section 6325(b)(2)(B), where the interest in the United States is valueless. The Service has no authority under section 6325(b)(2)(B) to require payment of the sum that otherwise would be applied to junior real estate transfer taxes as a condition of discharge. Because the interest of the United States is valueless, the result would be the same even if the senior lienholder was choosing to use a portion of its mortgage proceeds to pay a junior creditor of the taxpayer (such as payment of homeowner's association fees).
Essentially they are saying that the carve-out for transfer taxes is coming out of the banks secured interest and does not create some sort of equity that makes the IRS lien worth something. This document a letter to the director of collection policy (PMTA stands for Program Manager Technical Assistance) was dated September 17, 2010, but only recently came up on RIA. I haven't seen anything else on this so I am making this a bonus post in the interest of timeliness. If you are involved in a short sale that is hanging because of the IRS, it might be a useful reference.
The letter was sent to the Director of Collection Policy for Small Business/ Self Employed. It was copied to Special Counsel of the National Taxpayer Advocate Program, Assistant Division Counsel (SBSE) and Associate Area Counsels for Ft. Lauderdale and Jacksonville. So this may be a problem that is peculiar to Florida although the principle is of general interest.
In the comments below you will see feedback from Richard Zaretsky, an attorney specializing in short sales and related matters. He indicated to me that he has had shouting matches with the IRS on this issue. He has a blog dedicated to short sales. I've seen some misinformation on websites that would lead you to believe that an IRS lien will kill the possibility of a short sale. The relevant section of the Code is 6325(b)(2)(B) which indicates a lien with no value can be released and that in determining the lien's value other liens with priority will be taken into account.