A Short Sale Warning

I'm doing some research into the trend in personal bankruptcies this morning, and I came on this blog,Bankruptcy Law Network: It's by bankruptcy attorneys from around the country.

We get a lot of questions from homeowners interested in doing a "short sale." In essence, they'd like to walk away from their property rather than go through foreclosure. Although there's a certain lure and satisfaction to the idea of sending the keys to the house to the bank, it actually takes a lot of negotiation.It isn't easy, and there are pitfalls. Here's part of a post on the risks of a short sale and why foreclosure is not necessarily bad. It's by Attorney Craig Andresen of Bloomington, Minnesota:

...Without a release of liability on the mortgage note, the homeowner will continue to be liable for the unpaid balance owed on the mortgage, eliminating the entire reason for the homeowner to do the short sale in the first place. This means the homeowner needs to obtain not just a release of the mortgage, but a release of personal liability as well. Worse, the resulting debt forgiveness will be treated as income by the IRS. If the amount of the mortgage which is forgiven is substantial, the resulting income tax owed could present a serious, or even catastrophic, problem for the well-meaning homeowner. It may be necessary to hire a CPA to prove insolvency, if possible, to avoid the tax consequences of short sale mortgage debt forgiveness.

Additionally, many states have anti-deficiency laws, which forbid a lender from pursuing a homeowner for the unpaid mortgage balance after a foreclosure. This means the homeowner who agrees to do a short sale may unintentionally create a problem by doing so: either the homeowner owes the lender for the unpaid balance, or the homeowner owes the IRS for income tax on the forgiven mortgage debt. Plus, by doing a short sale, the homeowner gives up the right to remain in the home during often-lengthy foreclosure process.

A distressed homeowner contemplating a short sale as a means of avoiding foreclosure needs to think carefully about whether a short sale will solve the problem, or merely create additional problems.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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