U.S. Court of Appeals for the Seventh Circuit Gives Lender Victory Over IRS in Case Involving Future Rental Income

May 17, 2011, 2:39 PM

In the first appellate decision to consider the issue, the Seventh Circuit held on May 11, 2011 that an IRS lien filed prior to the collection of rental income from property on which a bank had a prior mortgage lien did not trump the banks lien (Bloomfield State Bank v. U.S. 107 AFTR2d 2011 (May 11, 2011)). The bank had recorded a mortgage against its borrowers real estate three years before the borrower defaulted. The IRS then filed its notice of lien pursuant to Internal Revenue Code Section 6323. The bank obtained the appointment of a receiver who subsequently rented the property for the banks account. The IRS argued that the rentals collected from the borrower were similar to accounts receivable and, therefore, did not arise until after the filing of the IRS notice of lien. Under Internal Revenue Code Section 6323, an IRS lien is not valid against the holder of a security interest until the notice of lien has been filed. One condition to having a security interest is that the property which is the subject of the security interest must be in existence. Rejecting the governments argument and reversing the lower court, the Seventh Circuit held that the real estate on which the bank had the lien was the property that needed to be in existence, not the rental income; the rental income was simply proceeds of such property. The Seventh Circuit noted that the lower district courts and bankruptcy courts had reached divergent conclusions. This case, however, should give lenders some comfort and help other Circuits that might address the issue. --Barry W. Hunter