How Short Sales Make the Best of a Bad Situation

What is a short sale?

A short sale is an option for distressed homeowners to avoid foreclosure and divest themselves of an “upside down” mortgage. Homeowners who won’t or can’t make payments to the bank might be able to negotiate an agreement with the bank to allow the sale of the property to a third party for a lower price than the outstanding mortgage balance. The difference between the sale price and the outstanding mortgage balance is less than the full amount owed, thus “short sale” is the term used in the industry.

Unlike foreclosure, a short sale sells the home to another person, and is usually only present when property values in an area drop quickly, such as in the recent recession.

Homeowners are usually (but not always) forgiven on the difference between the sale price of the home and the remaining mortgage balance. However, a short sale will severely impact a homeowner’s credit score for many years to come.

A short sale is different from a deed in lieu of foreclosure, where a bank accepts a deed transfer and owns the home.

Why would someone do a short sale?

A short sale can benefit distressed homeowners and banks in a number of ways.

For the homeowner, a short sale can mean avoiding the painful foreclosure process and allow all parties involved to gracefully exit.

For the bank, a short sale is the easiest way to divest an underperforming asset because it avoids the lengthy and expensive legal process of foreclosure. Although this will mean a loss on the bank’s books, it also means the removal of a non-performing asset off those books. For banks, it’s a question of math, and the numbers are often attractive. It also lets the bank avoid owning an illiquid asset which is expensive to maintain and can be difficult to sell.

What are the tax implications of a short sale?

The seller in a short sale may be forgiven the shortage of money that should have been paid. This does, however, have some tax implications, as the IRS may consider those savings to be income. Due to the fairly recent number of short sales throughout the country, however, the IRS has usually forgiven short sellers.

A short sale is an important decision. No homeowner should enter the process without the advice of an experienced real estate attorney. If you face this difficult decision and need some help to understand the process better and to protect your rights, contact us.

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