Tax Lien Takes Priority Over Earlier Interest Where Deed is Improperly Executed

In the recent case of The Bank of NY Mellon v. Ashley, et al., 119 AFTR 2d 2017-1207 (D.C. Md. 2017), the U.S. District Court for the District of Maryland held that, where taxpayer-husband alone executed a deed of trust in favor of a lender at a time when the taxpayers held property as tenants by the entirety, the lender’s security interest became perfected only when the taxpayer-husband acquired title to the property in a capacity other than as a tenant by the entirety.

The timeline was as follows:

• October 5, 1999: The taxpayer-wife acquired certain real property (the “Property”).
• November 24, 2003: The taxpayers recorded a deed conveying the Property from taxpayer-wife to herself and the taxpayer-husband, as tenants by the entirety.
• December 22, 2004: The taxpayers refinanced their mortgage on the Property; as part of the refinancing, WMC Mortgage, the predecessor to The Bank of NY Mellon, granted a $400,000 loan to the taxpayers in exchange for a deed of trust (the “First DOT”). The taxpayers used the WMC Mortgage loan to pay off an existing mortgage lien.
• July 5, 2005: WMC Mortgage granted the taxpayer-husband a $475,000 refinance loan; the proceeds from this refinance loan were used to pay off the First DOT. Only taxpayer-husband was identified as a grantor for the second deed of trust (the “Second DOT”) issued to WMC Mortgage in connection with the $475,000 refinance loan.
• July 7, 2005: The First DOT was recorded.
• July 14, 2005: The Second DOT was executed by taxpayer-husband.
• December 31, 2005: The Second DOT was recorded.
• June 5, 2007: The taxpayers conveyed the Property to a family trust and recorded a deed reflecting the same (the “Trust DOT”). Each of the taxpayers had a 50% undivided interest in the trust.
• November 5, 2012: The United States filed Federal tax liens against the taxpayers.
• December 21, 2012: The taxpayers’ family trust conveyed the Property to the taxpayer-husband.

The United States and the Bank of NY Mellon requested that the U.S. District Court determine the priority of the liens on the Property.

A tax lien attaches to all property owned by a person who fails to pay taxes owed to the IRS. I.R.C. § 6321. While a tax lien arises when the IRS assesses a tax liability against a taxpayer, the tax lien is not valid against another security interest until notice of the tax lien is recorded. A security interest exists if (1) the security interest has become protected under local law and (2) the holder of the security interest has parted with money or money’s worth. The court found that, in issuing the $475,000 refinancing loan, the Bank of NY Mellon had parted with money. Accordingly, the key inquiry was whether and when the competing security interests were perfected under Maryland law.

Under Maryland law, a deed of trust must list all grantors. Maryland law permits spouses to own property as tenants by the entirety, meaning each spouse has a right to 100% of the undivided property; spouses can terminate a tenancy by the entireties through joint action.

In 2003, the taxpayers took title to the Property as tenants by the entirety. Because the taxpayer-wife was not listed as a grantor on the Second DOT, the Second DOT did not create a perfected security interest when executed by the taxpayer-husband. When the taxpayers transferred title to the family trust, each spouse became the owner of a one-half interest in the Property as tenants in common. Accordingly, the Bank of NY Mellon’s security interest became protected on June 5, 2007, when the Trust DOT was recorded. Because this was prior to the filing of the Federal tax liens, the court concluded that the Bank of NY Mellon had a priority over the United States with respect to 50% of the Property. With respect to the other 50% of the Property, the court held that the Bank of NY Mellon could not have perfected its interest until the taxpayer-husband had the right to encumber 100% of the Property. This did not occur until December 21, 2012. Therefore, the Federal tax liens held priority with respect to the other 50% of the Property.

The Bank of NY Mellon case emphasizes that the priority of secured creditors is a fact-intensive inquiry. Legal requirements regarding the transfer of property and the execution of deeds must be complied with exactly in order to perfect a security interest in property. Creditors should be aware of the strict state requirements and be sure that debtors and creditors comply with all requirements in order to perfect a security interest.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Accessing this blog and reading its content does not create an attorney-client relationship with the author or with Miles & Stockbridge. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

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