It is possible to sell a house via a short sale even with a federal or state tax lien. In some cases, if the lien is a small amount, the mortgage lender might allow it to be paid in full out of the proceeds of the sale. For example, if the amount of the tax lien is $3,000.00 or less, many lenders will allow it to be paid at the settlement.
If the lien is substantial, the mortgage lender might only permit some of it to be paid. For example, if someone has a $20,000.00 tax lien, their lender might only allow $3,000.00 to be allocated toward the lien. In some cases, the lender will not allow any money to be disbursed to pay off the tax lien.
If the lender refuses to allow any proceeds to be paid toward the tax lien, then it is possible for the lien holder to permit the sale to occur. In other words, it is possible for the IRS or a state department of revenue to allow a short sale to occur without any payment toward the tax lien. Such relief is granted on a case-by-case basis, and typically an attorney needs to assist with the negotiation.