A mortgage foreclosure action is at times the lender’s only practical remedy for protecting the lender’s rights with respect to a real estate-secured loan in default. In this regard, foreclosure is even necessary where the borrower wishes to amicably surrender property without litigation if there are other liens and encumbrances against the property in junior lien priority to the mortgage. In that situation, generally the lender’s sole mechanism to divest the mortgaged property of liens is the foreclosure process. As a general rule, so long as the foreclosing creditor provides proper notice of the foreclosure sale to all parties having an ownership interest, a lien, or other interest in the property which is junior in priority to the mortgage, such interests are divested by the sheriff’s sale process.
The Pennsylvania Department of Revenue is responsible for, among other things, collecting the various types of taxes owed to the Commonwealth, one of which is inheritance taxes. Inheritance tax obligations arise if the owner of the mortgaged property passes away and therefore could arise in any foreclosure case where any owner of the mortgaged property has died (or dies prior to the sheriff’s sale). Under Pennsylvania law, inheritance taxes become liens on any real estate in which the deceased had an interest, including property subject to a mortgage. To further complicate matters, lenders are often unaware if a property owner has died, and inheritance tax liens are typically not filed of record, meaning a title search would not disclose them. For those reasons, inheritance tax liens are sometimes referred to as a category of inchoate or “secret liens.”
For many years, inheritance tax liens were considered just like most other judgments, liens and encumbrances on real estate; namely, the priority of such liens is determined by the date of filing or attachment. For example, if a property was subject to a mortgage at the time of the owner’s death, the property would be subject to a lien for inheritance taxes due as of the date of death, and the inheritance tax lien would be considered divested if notice of the Sheriff’s sale of the property was given to the Department of Revenue, Bureau of Inheritance Taxes.
However, the Department of Revenue has recently announced-for the first time-that it now takes the position that foreclosure sales do not divest the lien of unpaid inheritance taxes which come due upon the death of the owner of the mortgaged property. As a result, according to the Department of Revenue, any unpaid inheritance taxes remain a lien against a mortgaged property sold at sheriff’s sale (even assuming the Department of Revenue received notice of the Sheriff’s Sale in accordance with applicable law), unless and until such taxes are paid. As such, the successful purchaser (typically the foreclosing creditor) may need to address the unpaid taxes by, for example, paying them from the proceeds of sale if the property is later sold to a third party. This is the type of “parting gift” that no lender wants to receive. In this regard, the Department of Revenue has established a procedure for determining the amount of inheritance tax due on a parcel of real property, and for obtaining a release of the inheritance tax lien. This procedure can be located on the Department of Revenue website.
It is possible that the Department’s interpretation of the law on this issue may be successfully challenged in court. Until then, however, lenders will be forced to address this issue. Our firm has developed some solutions to address or mitigate the complications that can arise from inheritance tax liens on foreclosed properties, and we would be glad to discuss our recommendations with you.