Many of you have probably heard about "short sales". Have you ever wondered what they are? First, let me make it clear that I am neither an accountant or a financial advisor. The information I am placing here is just to make you aware of situations where you may wish to consult with either of those professions before making a decision about going the "short sale" route.
Here is what happens in a short sale. Suppose Joe bought his house in 2005 when prices were high for $250,000. He had excellent credit so he got an 80% first mortgage and a 20% second mortgage so he had 100% financing. He owed the bank $250,000. He lived in the home until 2007 making his monthly payments, most of which were interest on the loan. when he lost his high paying job and could no longer make his payments. He had to sell his home. But homes similar to his were now selling for $210,000. Prices had fallen. Yet he still owed over $240,000! Now if he could have stayed in the home several more years, the market might have rebounded so that it went back above what he owed, but he did not have that option. What could he do? He was not wealthy so he could not absorb the $30,000 difference. One answer would be bankruptcy which is a very serious step with consequences that can follow you for years. Another possible answer is a "short sale".
A short sale is when a bank/lender agrees to accept less than the amount of the remaining prinicpal of a mortgage as a satisfaction of the debt. In Joe's case, the first mortgage holder was probably owed, let's say, $195,000. They might agree to accept less so that Joe could lower the price of the home to a level where it could sell. Why would they do this? Well, not because they have big hearts. It is simply a way to avoid the costs and trouble of a foreclosure that could leave them with even less money in the end. Of course, the second mortgage company could be left "out in the rain" losing everything. So they are going to want a piece of the pie as well. So between the two lenders they work out what they both are willing to give up to get the price of the home to a saleable level. If they both are willing to forgive enough of what Joe owes them, he can lower the price of his home to a competitive level and sell it. Joe is off the hook. Right? Not quite.
Here is the surprise. The money that the banks forgive is considered income to Joe and will be reported to the IRS on the 1099 form. He may end up paying income tax on that amount. Think of it as a kind of money gift from the banks. At the start they lent him $250,000 now they forgiving, or letting him "keep", $30,000 of what he borrowed and that is income to him, as far as the IRS is concerned. This scenario is what you have to watch out for. You could have a nice little income tax bill waiting for you at the end of the year. If you are bankrupt or insolvent you may escape the taxes, MAY.
As I said, I am not an accountant or financial advisor. The best advice I can give you is that if you are considering doing a short sale of your home, do not just discuss it with your lenders. You should consult immediately with your tax attorney, accountant or financial advisor to learn what tax ramifications you may, or may not suffer if you have a short sale. Better to know ahead of time so you can make the best decision for your particular situation. It may be that a short sale is the best way to go for you. But check with the professionals
Housing and Urban Development (HUD) has resources for people who are having problems keeping their homes. You can access their pages at: http://www.fha.gov/foreclosure/index.cfm
For more information or questions about this topic please call me at: 813-783-4444 or e-mail me at: firstname.lastname@example.org
John Elwell - REALTOR
Bill Nye Realty, Inc.
Licensed in Florida