With the problems in the housing and mortgage industries, the values of homes have plummeted. Owners of these homes with debt that is greater than the market value of the homes are allowing them to be foreclosed upon or are trying to sell them short.

A “short sale,” in the real estate sense, is selling a home for less than what is owed on the balance of the mortgage and asking the lender to forgive the unpaid balance. For example, selling a home for $80,000.00 on which the mortgage lender is owed a balance of $100,000.00. You are proposing to sell the home $20,000.00 dollars “short.”

By short selling the home some owners are trying to protect their credit. They are hopeful that by short selling their home they will avoid a foreclosure on their credit report.

Not all lenders will consent to a short sale. Sometimes it makes more financial sense to a lender to foreclose. Not all sellers and/or properties qualify for a short sale in any event.

To Qualify for a short sale generally 1). The Market Value has Dropped. You must confirm for the lender that the home is worth less than the amount owed to the lender on the balance of the mortgage; 2). The Mortgage is in Default (although they may listen if you can show factors indicative of a pending default). If you are paying the mortgage, they generally will not consider a short sale; 3). You Have Suffered a Hardship. You must document the reason that you can not, as the seller, pay the difference due upon sale between the selling price and the balance you owe on the mortgage. You must explain why you have stopped or will have to stop making the monthly mortgage payments; 4). You, the Seller Have No Assets. The lender may want to see your tax returns or a financial statement prepared on your behalf to ensure that you have no ability to pay the difference between the short sale price and the balance owing the mortgage company. If you have assets that could be liquidated and used to pay the difference, your short sale may not be approved.

If you think that you as the seller and your property will both qualify for a short sale, how do you do a short sale? Each lender will have different requirements and procedures for determining whether they are going to qualify a seller and a property for a short sale, but generally the following steps can be expected:

1). Get in touch with the lender and find out who is the individual that determines eligibility for a “short sale.” You may be on the phone awhile, but you are going to need to talk to this person.

2). If working with a third party, i.e., a real estate agent, title company, lawyer, etc., forward a letter of authorization to your lender giving the lender permission to speak with this party (your agent) about your mortgage loan. Be sure to provide all necessary information regarding your name, loan number and your Agent’s contact information.

3). The seller signs a listing agreement with a real estate agent to list the property for sale. Until you have someone to buy the property, there can be no short sale. The Listing
Agreement will indicate that sale is subject to approval by third party (the lender who must agree to accept less than what is actually owed).

4). Your Agent locates a buyer who makes a formal offer to purchase (assumption is that offer is less than the mortgage balance or it’s not a short sale (If there is no buyer, there is no short sale either.)

5). The seller accepts the buyer’s offer (subject to approval by the lender). The Offer and other documents required by the lender (estimated closing statement, hardship letter, proof of income and assets, bank statements and financial records, comparative market analysis) are forwarded to the lender.

6). The seller’s mortgage lender accepts the “short” offer and agrees to forgive the balance. (If the lender doesn’t accept the offer, there is no short sale.)

7). The Real Estate Transaction is closed. Buyer delivers funds for purchase. Seller provides Deed. Lender releases the lien.

Does everybody win? Well, maybe, maybe not. There could be tax consequences. If you are still considering a short sale, it is strongly suggested that you speak with an experienced real estate attorney and a qualified tax professional to discuss the impact of a short sale of YOUR property.

Generally, forgiven debt is considered income by the Internal Revenue Service. This means that the IRS will expect to be paid income tax on the amount of debt that is forgiven. In other words the forgiven debt is taxed just like you received the forgiven debt in the form of a check from an employer. The lender forgiving the debt may forward a IRS form 1099C to the IRS informing the IRS of the debt that they forgave for you.

However, in the current state of the economy there may be some relief. Be certain to have your tax professional discuss with you the application of the Mortgage Forgiveness Debt Relief Act of 2007. This Act is in effect until December 31, 2009. This Federal Act excuses taxes on forgiven debt from a short sale of a primary residence. Be aware that it may not apply to an investment property, a summer home or a second home. Again, talk to a tax professional! Be certain that conforming legislation has been completed in your State.

By the way, debt discharged in a Bankruptcy case is not “forgiven” and therefore there is no tax consequence if the debt is discharged as opposed to forgiven. The tax man will not come knocking for taxes on debt discharged in a bankruptcy case.

A short sale will show up on your credit report. It may show up as a settlement or a pre­foreclosure redemption. A short sale is adverse information. Adverse information can stay on your credit report for up to 7 years (a bankruptcy can stay on for up to 10 years). While the short sale on your credit report may not seem as bad to you as a foreclosure, articles I have read suggest that the drop in your FICO credit score after a short sale are the same as after a foreclosure. Credit reports are somewhat subjective, the are to the person reading what they make them. The creditor reading the report may not make a distinction between a short sale and a foreclosure.

Always obtain legal counsel and tax counsel before undertaking a short sale. Remember, your real estate agent is earning a commission and has a monetary incentive to recommend that you do a short sale. Your real estate agent can not give you legal advice.

The information regarding short sales presented here is BASIC. Be sure you have discussed the possibility of a short sale of your property with both legal and tax professionals before you take the first step.

If you would like more information on the differences between how a short sale and a bankruptcy can help you out of your financial issue please give our office a call at 732-302-9600 or fill out our online consultation and we will call you.