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The Non-Statutory Priority of the Purchase Money Mortgage Over the Federal Tax Lien

Posted on July 11, 2016

The recent case of United States v. Heptner  (W.D. Fla. No. 8:15-cv-1125 June 15, 2016) demonstrates the lien priority status of purchase money mortgages vis a vis the federal tax lien.  In this case, the district court held that a purchase money mortgage defeated the federal tax lien.  The IRS acknowledged its long held administrative deference to purchase money mortgages despite the absence of language in the statute providing such a priority; however, it argued that a purchase money mortgage did not exist on the facts of this case.  Because of the IRS position deferring to purchase money mortgages, litigation on this issue rarely occurs.  The case provides the chance to examine the policy and to examine when it applies.

The Facts

The defendant, James Heptner, is a disbarred attorney.  He sought, at one point, to become a tax lawyer and began the LLM program at University of Florida – consistently rated one of the best LLM program for tax in the country; however, he dropped out prior to completion of his LLM degree because, in his words, he “didn’t have a knack for tax.”  He also did not have a knack for timely filing his tax returns.  In February 2004, he filed his federal tax returns for the years 1993-1996 and 1999-2001.  He did not fully remit the taxes shown on the late filed returns.  He also filed his 2010 and 2012 returns late without full remittance.  He obtained an installment agreement in 2005 but eventually fell behind.  The IRS filed notices of federal tax lien against him in Hillsborough County, Florida where he lived in September, 2004 after receipt of the first batch of late returns and in December 2014 after receipt of the second batch.  By March of 2016, he owed the IRS over $250,000.

Mr. Heptner practiced law in Florida from 1984 to 2001 and lost his law license because he “got into cocaine.”  Despite losing his license, an entrepreneur, Damien Freeman, hired him to provide legal services to his companies from about 2002 to 2009.   During this period, Mr. Heptner received a salary of approximately $50,000 per year and, according to him, he was entitled to profit sharing.  The two men were good friends and ate lunch together every day.  They talked about personal and business matters including Mr. Heptner’s divorce and custody battle.

In order to retain custody rights, Mr. Heptner needed to live near his daughter.  According to Mr. Freeman he had the company loan money to Mr. Heptner to purchase a home near the school Mr. Heptner’s  daughter attended.  According to Mr. Heptner’s testimony during the 2015 federal tax lien foreclosure action, at least a portion of the funds provided were distributions of his profit share at the company.  However, in June of 2005, during his divorce case, Mr. Heptner testified and filed a financial disclosure form stating that the money to purchase the house came from a loan from his employer.

In 2006, some time after the purchase of the house by Mr. Heptner occurred, Mr. Freeman’s company asked Mr. Heptner to sign a mortgage.  Mr. Heptner refused to do so.  The company filed suit against him and filed a lis pendens.  The company won the suit but on the date the final hearing was set to take place in state court, Mr. Heptner filed a Chapter 13 petition.  The bankruptcy case was ultimately dismissed and the state court litigation resumed resulting in a judgment that Mr. Heptner had defrauded the company; ordering him to vacate the property and compelling him to sign a purchase money note and mortgage.  During the 10 years that Mr. Heptner occupied the property, he paid the company nothing.  A judicial sale of the property was ordered so that the company could recover the money it gave to Mr. Heptner.  Eventually, after contempt proceedings were initiated against Mr. Heptner, he signed a note a mortgage in August 2015; however, in the meantime, the IRS brought suit in May 2015 to reduce the assessment to judgment and to foreclose the federal tax liens on the house.  Because Mr. Heptner had not paid property taxes or homeowners association dues, the county and the association were made parties to the foreclosure suit in addition to the company.  It’s easy to see why the IRS did not automatically apply its policy regarding purchase money mortgages since the company did not obtain a purchase money mortgage at the time it provided the money to Mr. Heptner.  This sets up the application of the administrative rule through which the IRS steps back from its priority position.   Here its notice of federal tax lien filed in 2004 predated the purchase of the property at issue, and because of the lack of a the filing of a mortgage at the time of the purchase, the IRS cannot apply its policy in a simple manner because of the absence of a mortgage.  The federal district court must decide if a purchase money mortgage does exist sufficient to trigger the application of an admittedly administrative remedy.

Court Grants Reduction of Assessment to Judgment

In two short paragraphs, the Court finds the assessment valid and grants the IRS a judgment for the amount of the liability.  While this provides only half of the relief the IRS requests, it turns the liability into one which will probably follow Mr. Heptner as long as he lives.

Applying the Purchase Money Mortgage Administrative Provision to These Facts

The Court then turns to the priority fight between the IRS and the company over the house.  The house purchase occurred in June 2005 and the IRS filed its first NFTL in September 2004.  The IRS argued that “absent a provision to the contrary priority [of IRS tax liens] for purposes of federal law is governed by the common-law principle that the first in time is the first in right.”  Although the Court does not cite to the statute, the principle stated here reflects the codification in the 1966 Federal Tax Lien Act of IRC 6323(a) which provides that the federal tax lien will defeat four enumerated parties – purchasers, holders of security interests, judgments and mechanic’s lien holders – when the IRS files the NFTL before the enumerated party perfects its interest.

The company asserts that a “provision to the contrary” does exist here because it loaned money as a purchase money lender.  It cites to language of the Supreme Court in a trust fund recovery penalty case, Slodov v. United States, 436 U.S. 238, 259 (1978) where the Court said “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.”  Critical to the language of the Court is Revenue Ruling 68-57 which states “[T]he 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 as been filed.”  In addition to Slodov, the court cited three other cases holding that a purchase money mortgage can defeat the filed federal tax lien.

The IRS replied that, despite the policy to defer to purchase money mortgages, the company must lose because it “failed to timely and properly perfect” its mortgage under Florida law.  The company could have required Mr. Heptner sign mortgage documents before it provided the money to purchase the property.  Instead, it just gave him the money and later requested that he sign a mortgage.  The court, interpreting the Revenue Ruling in which the IRS decided to defer in a circumstance the Federal Tax Lien Act did not require it to defer, finds that the language of the Revenue Ruling focuses on a valid mortgage and not a perfected one.  The court notes that in Florida the concepts of validity and perfection are distinct legal concepts.  Here, the state court has determined that the company has a valid mortgage even though the company did not properly perfect the mortgage at the time it provided the funds.  So, the court finds that the application of the Revenue Ruling allows the company to defeat the IRS with respect to lien priority in this property.

Last Ditch Effort by IRS

The IRS made a final argument that the company owed it money and that it should recover the proceeds of the sale to the extent of this debt.  The court found two problems with this argument.  First, the IRS had not yet assessed any liability against the company.  This seems like an insurmountable problem in the context of this case.  Even though the IRS can hold onto a taxpayer’s funds prior to making an assessment, the ability to “offset” a third parties funds prior to making an assessment moves this concept to a place it has not yet traveled.  Second, the court found that even if it could overcome the lack of an assessment, the IRS raised this argument too late in the proceedings.


If you ever needed an excuse not to lend money to a friend, read this case.  Mr. Heptner certainly makes life miserable for someone who tried to befriend him.  The purchase money mortgage exception, at least as interpreted here, has more flexibility than most lien priority fights because of the focus on validity rather than perfection.  The IRS promulgated the Revenue Ruling because it makes good policy sense to allow a purchase money mortgage to come ahead of the filed federal tax lien.  The IRS loses nothing when this happens and may gain an interest in property if the property increases in value above the amount of the outstanding mortgage.  The court’s focus on validity seems consistent with not only the language of the Revenue Ruling but also the policy underlying the Revenue Ruling.  Had the company not put up the money, Mr. Heptner would never have purchased the property and the IRS lien interest would never have attached.  Allowing the company to recover first, where it has proven that it did loan the money even though it did not follow strict formalities in perfecting its lien interest, places the parties in proper alignment.  The company defeats the IRS because it did loan the money to purchase the property.  The company still paid a high price in litigation costs for its failure to perfect in the first place.

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