Can I Buy a House if I Owe Back Taxes?

Owing back taxes can complicate the dream of homeownership. While it presents a challenge, it does not always make purchasing a house impossible. Understanding the implications of these debts is the first step toward navigating the process.

How Back Taxes Affect Your Financial Standing

Owing back taxes influences financial health and impacts mortgage security. Unpaid tax debts, especially those in collections, can appear on credit reports. While tax liens no longer appear, the underlying debt can negatively affect credit scores if sent to a collection agency. This makes obtaining new credit or loans more challenging and can lead to higher interest rates.

Outstanding tax obligations impact a borrower’s debt-to-income (DTI) ratio. Lenders use DTI, comparing monthly debt payments to gross monthly income, to evaluate a borrower’s ability to manage additional debt. Most lenders prefer a DTI ratio of 36% or lower, though some loan programs allow up to 43% or 50% for FHA loans. If a formal payment plan for tax debt is established, its monthly payment is included in this calculation, potentially increasing the DTI ratio beyond acceptable limits. Lenders may also view a history of unpaid taxes as financial instability, raising concerns about future mortgage obligations.

Understanding Tax Liens and Their Impact

A tax lien is the government’s legal claim against a taxpayer’s property when a tax debt remains unpaid. The IRS files a “Notice of Federal Tax Lien” publicly, usually with local county recorder’s offices, to establish priority over other creditors. This public notice informs potential lenders and the public about the government’s claim, making it difficult to sell or transfer property with a clear title.

States and local municipalities can also place liens for unpaid obligations like state income or property taxes. These liens function similarly to federal liens, attaching to property within their jurisdictions. Unpaid property taxes create a lien on the specific property, potentially leading to a tax sale. A tax lien encumbers the property title and must be satisfied or released before a property can be sold or refinanced.

A tax lien is a legal claim securing tax debt, while a levy is the seizure of property or assets to satisfy the debt. For example, a lien establishes the government’s right to property, but a bank account levy takes funds directly from an account. An IRS tax lien is released within 30 days once the tax liability is fully paid. Other conditions for release include an accepted Offer in Compromise or the expiration of the collection statute of limitations, which is 10 years from assessment.

Mortgage Lender Considerations

Mortgage lenders use underwriting standards to evaluate a borrower’s creditworthiness and repayment capacity. This includes reviewing credit reports for payment history and public records for judgments or liens. Lenders also verify income stability, employment history, and all existing debt obligations, including outstanding tax liabilities.

An active tax lien, whether federal, state, or local, is a barrier to mortgage approval. Lenders consider liens as claims against the property that could take precedence over their mortgage in a default. Most conventional lenders require the full release of any recorded tax lien before approving a mortgage, as they need a clear title to protect their investment.

If a borrower has an established payment plan with the IRS, such as an Installment Agreement, lenders may view this more favorably than an unresolved lien. Many lenders, including those for FHA and VA loans, require proof of consistent and timely payments for a certain period, often three to six months for FHA loans. The Installment Agreement’s monthly payment is factored into the borrower’s debt-to-income ratio. VA loans require at least 12 months of on-time payments on an IRS payment plan if a tax lien is present.

Lenders require official documentation to verify the resolution status of tax debt. This includes IRS Form 668(Z), “Certificate of Release of Federal Tax Lien,” or comparable state/local documents proving the lien has been satisfied and released. For payment plans, borrowers must provide the signed Installment Agreement and evidence of on-time payments, such as bank statements or payment receipts.

Addressing Unpaid Taxes Before Buying a House

The most direct approach to mitigate back taxes is to pay the full amount owed, including penalties and interest. Once settled, the tax authority will issue a release of any associated lien, usually within 30 days for federal tax liens. This provides documentation for mortgage lenders, confirming the financial obligation’s resolution.

If immediate full payment is not feasible, an Installment Agreement with the IRS or state tax agency offers a structured repayment option. This arrangement allows taxpayers to make monthly payments, commonly up to 72 months for federal taxes. Being current on such an agreement for a few months can satisfy lender requirements, demonstrating a commitment to resolving the debt.

An Offer in Compromise (OIC) allows taxpayers to settle their tax liability for a lower amount than the full balance due. This option is considered when there is doubt as to collectibility or liability, or when collecting the full amount would cause economic hardship. While an accepted OIC can lead to a lien release, the process is complex and requires meeting eligibility criteria, including being current on all filing and payment obligations.

The IRS may agree to subordinate its lien, allowing a new mortgage to take priority over the federal tax lien. This does not remove the lien but changes its collection priority, which can be important for obtaining new financing. A request for subordination, made using IRS Form 14134, is considered when it is in the government’s best interest, such as facilitating tax liability collection.

Regardless of the resolution method, obtaining official documentation from the tax authority is important. This includes certificates of lien release, confirmation of payment plans, or letters acknowledging accepted Offers in Compromise. Lenders require these documents to verify the tax debt’s status before proceeding with mortgage applications. Seeking advice from a qualified tax professional or real estate attorney can provide tailored guidance.