Can the IRS Enforce a Judgment Lien on Gifted Property?
When facing an IRS audit, it might seem expedient to take steps to protect your assets from collections. You might consider giving your home to your children, for example. But this only raises a new question of whether the IRS can enforce a judgment lien on gifted property. As a recent District Court case from Virginia demonstrates, that gift can sometimes be called fraud.
22 Year Old Elder-Care Agreement Wasn’t a Property Transfer
Constantin Kotzev knew that he was getting older. In May 2000 he signed an agreement with Angelika Chyla, his niece, and George Chyla, his nephew. In that agreement, Kotzev promised to transfer his condominium in Arlington, Virginia, along with its parking space, purchased separately, to his niece and nephew, in exchange for their promise to provide support in his old age or should he become infirm. The agreement was finalized, but Kotzev never executed a deed completing the transfer. Nor was the agreement itself recorded in the Arlington County, Virginia land records.
IRS Seeks to Enforce a Judgment Lien on Gifted Property
Years later, in 2011, the IRS began auditing Kotzev’s 2008 tax return. (This audit was later expanded in 2013 to include 2006 and 2007). Throughout the audit, Kotzev denied holding any foreign financial accounts.
On December 6, 2013, While the IRS audit was going on, and after Kotzev had hired a tax attorney to represent him in that procedure, Kotzev executed and recorded two “Deed[s] of Gift” transferring his ownership interest in the condo and parking space to his niece and nephew. By that time, the condo was worth approximately $400,000. Those deeds indicated that the property had been exchanged for $10 and other consideration. They were marked as gift deeds under Virginia law, exempting them from state recordation tax. He continued to live in the Arlington condo and maintain the property, including paying the condominium association fees, property taxes, and utilities. After that transaction was complete, Kotzev’s only substantial asset was his vehicle.
Eventually, in 2017, Kotzev paid the IRS $723,387.85 in unpaid taxes for 2006 through 2008, and the IRS got a judgment for nearly $1.3 million in FBAR penalties relating to Kotzev’s undisclosed foreign financial accounts. The IRS sought to collect those penalties by enforcing a judgment lien on the gifted property. When the IRS took Kotzev and the Chylas to court to enforce its judgment lien on the gifted property, it said that the 2013 deeds were fraudulent. This would allow it to set aside the conveyance and collect part of the judgment amount through a forced sale of the condominium.
Virginia Real Estate Law Says Transaction of Gifted Property was Fraudulent
Because the property was located in Virginia, the United States District Court for the Eastern District of Virginia applied that state’s real property law to decide whether the gift was valid. Virginia law allows a court to set aside constructive or actual fraudulent transfers. The District Court found that Kotzev’s arrangement counted as both.
Constructive Fraudulent Transfers
Virginia law allowed pre-existing creditors to ignore a voluntary conveyance of real property if:
- The transfer was not made for valuable consideration (the property owner didn’t get anything valuable in exchange for the property)
- The transferor was insolvent or became insolvent as a result of the transfer
- The debt existed before the transfer occurred
Since the condominium was gifted property, Kotzev received no consideration at the time of transfer. He framed it that way to get the benefit of a Virginia tax exemption. Kotzev was insolvent after he transferred the property, leaving him owing nearly $1.3 million in tax penalties with only a vehicle in his name. Since FBAR penalties accrue on the date each filing is due, the IRS became Kotzev’s creditor in 2006, well before the 2013 transfer.
Actual Fraudulent Transfers
In addition, an actual fraudulent transfer may be set aside if:
- There was a conveyance of property
- Given with the intent to delay, hinder, or defraud creditors
- The creditor was lawfully entitled to the property conveyed
- The purchaser did not provide valuable consideration or had knowledge of the fraud or the grantor’s fraudulent intent
Most of the same analysis applies here as in the constructive fraudulent transfer analysis above. To determine whether there was an intent to delay, hinder, or defraud creditors, the Virginia law looked to so-called “badges of fraud”:
- If the transferor retained an interest in the property
- Transfers between family members
- If creditors were pursuing collections at the time of the transfer
- Lack of adequate consideration
- Retention or possession of the property by the transferor
- Fraudulent incurrence of debt after the conveyance
- Close relationship of the parties
- Insolvency of the grantor
Here, the Court noted that Kotzev retained an interest in the property since he continued to live there. The transfer was to close family members at a time when he was aware of the threat of litigation. The transfer left Kotzev insolvent, and the Chylas admitted they paid no money for the property. Based on this, the Court found that there was a “prima facia” showing for both constructive and actual fraudulent conveyance.
IRS Could Enforce a Judgment Lien on Gifted Property Even if Recipients Had No Fraudulent Intent
Once the Court found that the transfers appeared fraudulent, it was up to Kotzev and the Chylas to prove that they were not. The taxpayer and his relatives tried to rely on the May 2000 agreement. However, the Deeds of Gift did not refer to that agreement, and it was not recorded as required of such contracts to give them superior effect over later creditors. The Court also questioned whether the agreement to provide future support and care would have counted as valid consideration in 2000. The Court said the agreement “fails to provide a strong ‘countervailing explanation’” for what appeared to be a fraudulent transfer of gift property. It said:
“For example, nothing in the agreement required Kotzev to wait over thirteen years to execute deeds transferring the Real Properties.”
It also didn’t matter that the Chylas had no intent to commit fraud. The Court went out of its way to say “nothing in this Memorandum Opinion is intended to suggest that the Chylas acted with fraudulent intent or anything other than a genuine commitment to provide support to Kotzev in his old age.” But that didn’t matter, legally. Instead it was Kotzev’s intent, and his actions, that demonstrated the transfers were fraudulent. Ultimately, the Court allowed the IRS to enforce its judgment lien on the gifted property, setting aside the transfer as fraudulent pursuant to Virginia law.
Taxpayers should not try to get creative on their own when facing a tax audit. There may be ways to legally reduce liability and limit what the IRS can collect. However, these decisions should be made with the help of an experienced tax attorney. Otherwise, the Court may find the transfer fraudulent, and allow the IRS to enforce the judgment lien anyway.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 35 years experience. If the IRS is trying to enforce a judgment lien against you or your clients, contact Joe Viola to schedule a free consultation.