If you have a short sale property with an IRS tax lien, the IRS will remove thier lien and allow you to sell the home. It takes WORK but it can be done!
In cases where the homeowner has not paid their income taxes, the IRS may place a federal tax lien on the property. Actually, the lien covers all of the person's property including the home. Typically, you can convince the IRS to remove the tax lien (from the house) by requesting a Certificate of Discharge of Property from Federal Tax Lien (Publication 783) with the IRS.
The reason the IRS has placed the lien on the person's home is so that they will get paid whenever the person sells their property. If you can convince the IRS that the homeowner is upside down and that there will be no resulting proceeds from the sale, the IRS may agree to release their lien. Along with your request, you will need to include some supporting documentation such as the purchase contract, the payoff statement from the bank, and so forth.
I have had to deal with IRS tax liens on several occasions, and they are not fun. However, there is no way to move the short sale transaction forward until the IRS tax lien has been removed.
This entire process should be coordinated in conjunction with your title company or attorney. Make certain that you are working with a title agent who knows the ins-and-outs of the partial release of lien process. For more information and complete instructions, go to www.irs.gov and search for "Publication 783."
Happy Short Selling!