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A certain tax payer is on a payment plan to the IRS. The tax payer owes $10,000. The tax payer has missed several payments and now the IRS is going to take away the tax payer's car. The car is worth about $11,000 however there is an outstanding loan on the car of about $4,000. Assuming the IRS takes the car for non-payment of taxes, who pays off the car loan? Does the lender get stuck?

Note: Assume the person is in the United States.

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Assuming the IRS takes the car for non-payment of taxes, who pays off the car loan? Does the lender get stuck?

The lender does not get stuck.

The U.S. Treasury takes the car subject to the car loan. It then sells the car at auction and keeps as a credit against the taxpayer's tax liability, the money that is left over from the auction sale price after the costs of sale and the payoff of the lender (including any penalties, attorney fees, and default interest accrued).

Usually, the auction price is much less than the fair market value of the car sold by a used car dealer in the ordinary course.

In the facts as given, a sales prices of $7,000-$8,000 might be typical, with costs of sale on the order of $1,000, and a payment $5,000 to the lender once penalties for having the car foreclosed upon are considered, resulting in a net credit against tax liability of $1,000-$2,000.

What If The Auction Sale Price Less Costs Of Sale Doesn't Cover The Entire Car Loan?

If the sale price were insufficient to pay the car loan with all penalties and interest and the costs of sale, the U.S. Treasury would get nothing, and the car loan lender could sue you for the balance which still remains unpaid after the auction, which is called a "deficiency judgment." This would be an open and shut lawsuit, since having the car seized is an event of default and any fault in how the sale was conducted couldn't be attributed to the bank. If the deficiency is small (e.g. $100-$500), the lender might send collection letters, or file a claim in a bankruptcy if there is one, but not bother to sue.

What If The Lender's Lien Wasn't Filed With The DMV?

All of this assumes that the car loan was property documented with a state Department of Motor Vehicles filing. If the loan wasn't properly documented on the certificate of title (or a certificate of title whose issuance is pending), the entire sales price, after the costs of sale, is a credit against taxes owed (probably $6,000-$7,000 in this example). In that case, the foreclosure is still an event of default under the car loan, and the car lender can sue the borrower for the entire amount of the loan plus interest, penalties, and usually attorney fees (probably $6,000 to $7,000 in all in this fact pattern, because a lawsuit has to be begun rather than relying on the IRS to do some of that work).

Also, if that happens, the car lender fires its attorneys and sues them for malpractice if it can't collect the balance it is owed on its car loan. I'm familiar with a case where that happened in a $10 million transaction, for property much more valuable than a used car, and the lender prevailed.

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The lender is paid first

Assuming the lender has properly registered a lien under the Personal Property Securities Act then they have first right to the proceeds of the disposal of the vehicle. Assuming it realises $11,000 (i.e. after the costs of seizure and sale), the lender gets $4,000, the Australian Tax Office (ATO) gets $7,000 and the taxpayer still owes $3,000 to the ATO.

If the lender has (foolishly) not registered their interest then the ATO gets $10,000, the taxpayer gets $1,000 and still owes the lender $4,000.

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    though typically in a government auction, items end up only realizing a fraction of the item's real value on the open market. That doesn't quite hold true for real estate always.
    – Trish
    Commented Jul 1, 2023 at 23:43
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    @Trish yes. But the “market value” of an item is the price it realises when sold by an unmotivated seller to an unmotivated buyer - an auction is the closest you ever get to this.
    – Dale M
    Commented Jul 2, 2023 at 1:18
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    @DaleM Usually the definition of market value includes a phrase "under no undue time constraint" of something similar. The time constraint is one of the reasons that auction prices are low as it is sold at the best price available at that moment. Another reason that auction prices are low is that careful inspection of the property sold is typically not allowed so a bidder has to hedge against the risk of non-obvious defects in the property sold by offering a lower price.
    – ohwilleke
    Commented Jul 3, 2023 at 23:42
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    @ohwilleke but auctions in a “sellers’ market” can achieve unusually high prices. It all depends.
    – Dale M
    Commented Jul 3, 2023 at 23:51
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    @DaleM There is no doubt that this happens in some auctions. But, in a tax sale of a used car that isn't exceptionally valuable if sold in the ordinary course, almost never.
    – ohwilleke
    Commented Jul 3, 2023 at 23:53

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