Beware Of Short Sales

Many people who invested in real estate at the end of the boom are in financial trouble. I have been getting more and more inquiries from individual investors facing foreclosures of their investment properties. Often, people tell me they are discussing "short sales" with their mortgage lenders. In a short sale, the lender allows the house to be sold for less than the mortgage balance. The borrower avoids a deficiency judgment. The lenders would rather get most of their mortgage through a sale arranged by the owner then take the property back at a foreclosure sale. Borrower should beware of short sales.

The problem for the borrower in a short sale is that the difference between the payment to the mortgage company and the full mortgage balance is a forgiveness of debt for tax purposes. The mortgage company is forgiving the debtor’s liability for the deficiency. The IRS considers forgiven debt to be taxable income to the borrower. The mortgage lender may send the borrower a Form 1099 for the amount of the deficiency. Most borrowers who cannot afford mortgage payments can even less afford additional tax liability. Owing money to the IRS is usually worse than owing money to a mortgage lender. Many mortgage lenders will not pursue debtors for deficiency judgments; the IRS will always pursue unpaid taxes. For that reason, most borrowers will fare better by letting their property go to foreclosure, even if the foreclosure may result in a deficiency liability.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida

Comments

[Christine Egley]

I recently sold a property that had a first and second mortgage via short sale. Both mortgage companies accepted the amount of monetary funds they would be receiving. Two months after the property has been transferred to the new owners, the second mortgage company is now coming after me saying i still owe them the remaining balance of $43,000.00. I know there is now a law in place in Nevada protecting people from mortgage companies coming after restitution from short sales. Is there any similar laws in Florida that are in effect? Please let me know.

[Angie]

@ Dar Car,

You should be protected by the 2007 Mortgage Relief Act which has been extended until 12/31/2012.

Please visit: http://www.irs.gov/taxtopics/tc431.html

You have to report this weather you receive a 1099 C or not when you file your tax return; however if you qualify then you will not be taxed on this "income". If you can prove you were insolvent at the time then you should be safe. However if you have money and just decide to foreclose / short sale because you are so underwater then you have something to worry about.

Something else you should be aware of... There are some states that ban lenders from collecting the remainder owed on a loan after a foreclosure or short sale is completed; however some states allow banks to come after you for up to a certain amount of time (in Florida up to 20 years!).

Good Luck!
-AJ

[dar car]

To Mark in FL. You wrote that you did two short sales , one in 09 and one in 2010 with no negative feed back from the IRS. I'm getting ready to close on a shortsale with Bank of America and I'm so scared that they will 1099 me and I will owe the IRS taxes on $40,000, (the shortage amount) I can't sleep I'm so worried. Did you get an Estoppel from your lender? Thanks, Dar

[Keli Arnold]

We lived in our primary residence for 10 years. It has been on the market for 4 years We also own a second home. We changed our homestead exempt to the second home in 2010 and have moved into it so that we can proceed with either a short sale or foreclosure on the first home. We concluded it would be less costly monthly for us to do this. We have lost our construction business and our jobs. We are now concerned that th first home will not be considered our primary home and we will not be eligible for the $250,000 exemption offered under the tax relief act of 2007. I read that if we live in it for 2 of the last 5 years we can still consider it to be our principal home. Is this true? We owe $650,000 on our first mortgage and $260,000 on the line of credit/ second mortgage. We have been told that a short sale may only bring $450,000. Would we be better off to go through with the short sale or forclosure for tax liability purposes? We have already accepted the fact that our credit is ruined.

[Simone Griffin]

Yes, A Short Sale can be done on a second home.
It is always better to do a Short Sale as your lender wants to get the property back. They are more agreeable not to come after you for deficiency judgments when you let someone help you with the process. A reputable company will handle your whole short sale sale start to finish and then a buyer will have a new place to live. Everyone wins.

[Simone Griffin]

Short Sales Get Partial Doc Stamp Relief

The new Florida real estate law dealing with short sales lowers the amount of state taxes residents pay when they sell their homes through a short sale (the sale price is less than the outstanding debt). The state will not collect taxes on the canceled debt, or the difference between the sale price and what is owed on the house.

[Paul Blume]

Sorry about the caps on last post. I should have said after a short sale closing, how can I stop the ex-owner from staying 1 week until the end of the month? We are in Florida if this helps. Just need to know if I should even bother and just let them stay the week as it would be more trouble to fight 1 week than to just let them finish the month? Please let me know if I needed to get in there do I have any rite to lock them OUT!!!! Thanks, Paul

[Paul Blume]

HOW SOON AFTER THE CLOSING HAS BEEN SIGNED DOES THE EX-OWNER HAVE TO GET OUT OF THE HOUSE. THEY ARE SAYING THEY WANT TO STAY ONE MORE WEEK TO BE ABLE TO GET THIER THINGS TOGETHER BUT WHAT IF i DON'T WANT TO LET THEM? dO i CHANGE THE LOCKS, OR WHAT CAN i DO?

[Mark, FL]

I did two short sales; one of my primary in Sept. '09 and an investment property in April '10.

So far, neither has had any negative affect on me other than my credit report, but I knew that going in. The weight off my shoulders was amazing.

The sale of my primary resulted in a debt forgiveness of over $150k and I believe there is a law in effect that will negate the IRS taxes due on this, but check with your tax advisor.

Also, there is a tax form that you can complete that if you are insolvent (broke, essentially) when the debt is forgiven and you can prove it (bank statements, credit card statements, LOC statements, etc.) then the tax on your debt forgiveness is negated as well.

[Dennis Mc]

If only I did some research before my short sale I would feel better about it.I'm not sure if this is a good deal please help..I feel behind due to loss of hours at work and the value of the home was cut from 127,000 to 25,000.My wife and I decided to short sale and rent on a better side of town. So I contacted a close friend who is a Realtor and she started the ball rolling.After a year and 2 months we finally have a buyer.So we are now getting ready to close and Bank Of America wants us to sign a promissory note with $250 for closing cost with an agreement to pay $3,000 as well.Is this right so far?? Now I;m worried about the 1099, what should I demand from BOA to not get hit by IRS? I'm not so worried about my credit would foreclosure be a better option and do you think my Realtor would be pissed about not making a commission If I decide so. I do not want to owe IRS I am already in debt to them. C Mc in Fla