Dickson TN Real Estate

Many of you like me, are hearing more of this term, short sale, with the market the way it is.  It is often associated with the topic of foreclosures.  However, it is not only used for a pre-foreclosure sale.

So what is a short sale?  A short sale is a sales transaction in which the seller’s mortgage lender agrees to accept a payoff of less than the balance due on the loan.  In this blog, I am going to cover the affects a short sale has on your credit and the possible taxes that may be incurred afterwards.

Here is a to a video clip from The Early Show. Ray Martin chats with Hannah Storm about the advantages of the short sale.  If you don’t want to watch the video, I have taken an excerpt from his report on short sales.

http://www.cbsnews.com/video/watch/?id=2960979n

Lose the House, but Not Your Credit
According to sources in the mortgage industry, people who agree to a short sale with the lender do far less damage to their credit rating than those who go through foreclosure.
While in both cases, short sale and foreclosure, the delinquent mortgage will negatively affect their credit rating, at least short sellers avoid

having a “debt discharged due to foreclosure” on their credit reports. Mortgage and credit experts say that, after bankruptcy, having a foreclosure on your credit report is the worst result and will reduce your credit score by over 250 points. You could also have to wait up to three years to qualify for a mortgage at a reasonable rate.
Short sales show up on a credit report as a “pre-foreclosure in redemption” status and can result in a credit score reduction of 100 points or less. After the sale, the mortgage may show up as “discharged.” People who successfully complete a short sale may also qualify for a mortgage at a reasonable interest rate in as little as 18 months. So, if buying a home is a future goal, then a short sale is the better option for many.
Homeowners cannot simply decide that they want to unload a home with a short sale; the lender must agree to it. The key to getting a lender to go along is to demonstrate two things: that you have no other financial resources to pay the mortgage, and that the sale price the buyer is willing to pay is the fair price the market will bear. If a lender believes it can get more for the house by taking possession of it and selling it themselves, then they will not go along with a short sale.
To begin the process of a short sale, you first need to call the lender and speak directly with the person in the loan workout or short sale department. At GMAC ResCap, a large residential mortgage lender, there is a “foreclosure prevention department” with people trained to work with homeowners in exactly this situation. Their motivation is summed up by Steve Nelson at that company: “We pretty much know what our loss is going to be if we foreclose. If a short-seller results in a payoff that’s better than that number, we’re talking all day long with people who want to put a short sale together.” Some lenders report a three- to four-times rise in the number of short sales over the past year.
People who want to go this route should contact a local real estate firm and ask to work with a real estate agent who has actual experience with short sales. These specially trained agents will know the process and deliver the documentation that the lender requires to authorize the short sale. The agent can also find a buyer that is qualified to complete the transaction.
If all goes as planned, the lender will receive all of the proceeds, typically not enough to pay off the loan. The remaining balance of the loan is discharged. But a homeowner agreeing to a short sale should also get legal advice to protect his or herself from future claims of the lender. In some states, only purchase mortgages are fully discharged. For all other types of debt (equity loans, refinancing, etc), the homeowner can be held personally liable for repayment in the future. For this reason, a lawyer’s advice will include getting the lender to agree to fully discharge all mortgage debt involved in the short sale.]

One thing that Ray Martin did not cover in this excerpt is that you need to seek professional tax advice regarding the possible tax consequences of selling your home.  I have listed some tips below from my REALTOR magazine.

How Debt Forgiveness Works
With a short sale, the lender has three possible ways to handle the deficiency balance, which is the portion of the mortgage debt not covered by the sale of the home. First, the lender can attempt to collect the deficiency balance from the seller after the property has closed. Second, the lender may require the seller to sign an unsecured promissory note for the deficiency balance as a condition of agreeing to the short sale. If the new note is for less than the balance of the original debt, the difference would be considered canceled, or forgiven, debt. Third, the lender may agree to cancel the entire deficiency balance.
On the surface, option three would be seem to be the best alternative for a seller. However, the IRS considers any canceled mortgage debt ordinary income. This means that the amount forgiven is taxed at the same rate — somewhere between 15 percent and 30 percent — as the sellers’ salaries. In addition, because the IRS requires the lender to file a 1099-C form stating the amount of the canceled debt, Uncle Sam will have a record of the exact amount of the debt that was cancelled. A seller will also receive a copy of the 1099-C to use in filing income taxes. The seller’s home state would also consider the cancelled debt as ordinary income.

4 Exceptions to the Rule
The IRS does recognize four situations in which cancellation of debt will not result in tax liability for the seller. A seller may avoid tax liability:

• When the borrower receives a bankruptcy discharge and the deficiency was included in the bankruptcy
• When the borrower is insolvent at the time of the cancellation of the debt. Insolvency would occur when a borrower’s liabilities exceed assets. Note that seller would have to prove this insolvency to the IRS when filing a tax return.
• When the debt was secured by a nonrecourse loan. Under a nonrecourse loan, the lender does not have the legal right to collect a deficiency judgment from any assets of the debtor not pledged to secure the loan. While most home mortgages are do not fall into this category, purchase money loans on a person’s residence are nonrecourse in some states.
• When the tax liability from the cancellation of debt on an investment property can be offset against other business liabilities and expenses. This exception does not apply to properties occupied as a residence by the mortgagor.
  In many short sales, a seller would be able to qualify under the first two of these exemptions, especially since it was almost certainly necessary to show financial hardship in order to convince the lender to agree to a short sale. However, it is the seller’s responsibility to notify the IRS why the amount in the 1099-C should not be counted as ordinary income. Otherwise, the IRS will consider the forgiven debt as income and penalize the seller for unpaid taxes.
  

This entry was posted on Friday, August 22nd, 2008 at 9:55 am and is filed under Financial Advice, Mortgages\ Loans, Real Estate. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.