Robert Bruss: Can IRS take house fraudulently transferred to son?

In 1992, Rosalina and Coriolano Verduchi owed $82,000 to the Internal Revenue Service for unpaid income taxes as determined by the U.S. Tax Court. While this tax debt was unpaid, they transferred title to their home to their son, Dennis.

A year later, the unpaid taxes had grown to almost $400,000 because of interest. In 1994, the IRS filed its notice of tax lien.

In 1996, Rosalina and Coriolano filed Chapter 7 bankruptcy and discharged their debts. However, because the fraudulent transfer of the house, which would have been available to pay the $400,000 tax lien, was invalid under state law, the IRS argued the transfer of the house to Dennis was fraudulent so the tax lien should apply to the house.

Meanwhile, Dennis obtained a $196,000 mortgage on the house from Option One Mortgage Corp. The IRS then sought (1) to foreclose its tax lien against Dennis’ house, plus (2) $196,000 from Dennis for the cash he obtained from the house when he obtained the Option One Mortgage.

If you were the judge would you allow the IRS to foreclose its tax lien on the fraudulently transferred house and receive $196,000 from Dennis for the equity he borrowed against the house?

The judge said “yes.”

A fraudulent transfer occurs, the judge began, when a debtor conveys assets, such as the house in this case, without receiving adequate consideration in return. If the house had not been fraudulently transferred to Dennis, when Rosalina and Coriolano filed Chapter 7 bankruptcy, the house could have been sold to pay the IRS debt, and the unpaid balance would have been discharged.

However, in a fraudulent transfer case like this, the judge continued, the IRS can elect to foreclose its tax lien against the fraudulently transferred property and/or bring an action against the transferee of the taxpayer.

Dennis does not argue that the house was not fraudulently transferred to him, the judge noted. Nor has the amount of the IRS tax lien, now approximately $875,000 with interest, been contested, he added.

Because Dennis paid nothing for the house, he will not suffer any out-of-pocket loss, the judge emphasized. Therefore, the IRS is entitled to foreclose its lien against the fraudulently transferred house and Dennis is ordered to pay to the $196,000 he received from the mortgage he added, the judge ruled.

Based on the 2006 U.S. Court of Appeals decision in U.S. v. Verduchi, 434 Fed.3d 17.