The 7th Circuit Court of Appeals had to decide whether the relevant property in a dispute between a bank and the Internal Revenue Service was the real estate the bank owned or if it was the rentals of that property. Whether the IRS’ tax lien could take priority over the bank’s lien hinged on the answer.
In Bloomfield State Bank v. United States of America, No. 10-3939, Bloomfield State Bank sued in federal court for declaratory relief after the IRS filed a tax lien against real estate in which the bank held the mortgage. The mortgage was secured by the borrower’s real estate as well as all rents derived or owned by the mortgagor directly or indirectly from the real estate or improvements. Three years after obtaining the mortgage, the borrower defaulted and the IRS filed the tax lien against the real estate. A receiver was able to collect more than $80,000 in rent after renting some of the property. The IRS claimed it should be entitled to this rent collected after the tax lien was filed. The District Court granted summary judgment in favor of the IRS.
“The District judge based his decision primarily on the analogy of rents to accounts receivable; accounts receivable that come into being after a federal tax lien attaches to the assets that generate them have been held not to trump the tax lien,” Judge Richard Posner wrote.
“The ‘property’ that must be in existence for a lender’s lien to take priority over a federal tax lien is the property that, by virtue of a perfected security interest in it, is a source of value for repaying a loan in the event of a default; it is not the money the lender realizes by enforcing his security interest,” he continued.
The judges found that the real estate that generated the rental income at issue existed when the mortgage was issued and thus before the tax lien attached. The rental income was proceeds of that property, which pre-existed the tax lien.
“By virtue of the rental-income provision in the mortgage, the bank had a separate lien on the rents, but that is not the lien on which it is relying to trump the tax lien,” wrote the judge. “The lien on which it is relying is the lien on the real estate. If an asset that secures a loan is sold and a receivable generated, the receivable becomes the security, substituting for the original asset. The sort of receivable to which the statute denies priority over a federal tax lien is one that does not match an existing asset; a month’s rent is a receivable that matches the value of the real property for that month.”
The 7th Circuit reversed and remanded with directions to enter judgment for the bank.