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Short Sale Your Home – Risks & Potential Penalties

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If you are considering selling your home this year be prepared for a long and painful process. Many sellers are being forced into lowering their property prices to ridiculous levels or risk following the almost inevitable path into the darkness of foreclosure. Another option is to attract a buyer willing to consider going through the short sales process. However you must be ready to consider the risks and potential tax liabilities in short sale transactions.
 
One way out of the home seller’s dilemma is through the short sale process. Buyers are trying to find deals and sellers need to get out from under their mortgage. Both interests are served within the context of a declining real estate market and the lack of available bank credit.
 
For homeowners who are looking to sell their home through the short sales process, it’s usually because the seller is in financial distress and hoping to avoid having to file for bankruptcy or go through home foreclosure. For buyers, the short sale can represent a serious money making opportunity – assuming they can get the deal to actually close.
 

Adjust Your Expectations - Short Sales Are Highly Unpredictable

 
In most states hit hard by the recession, home purchases via short sales have become increasingly problematic and nearly impossible to get approved, documented and finalized. So before investing your time and personal resources finding and negotiating a short sale, remember to be realistic and know the chances of actually closing the transaction is probably very small.
 
With foreclosures reaching record levels, many sellers and buyers are electing to engage in short sale property transactions. However, both buyers and sellers should be careful to consider the potential tax consequences and risks involved in a short sale transaction before they begin the home search and negotiating process.
 

Possible Tax Liability In Short Sales

 
A short sale occurs when the sales price is not sufficient to meet the seller’s mortgage obligations. By using the short sale process, the lender can agree to accept a buyer’s offer and forgive the balance still owed by the seller. The lender gets their money, the buyer gets a great deal and the seller has the opportunity to save his or her credit and avoid the pain and anguish of going through home foreclosure.
 
However, short sales can have significant tax consequences. That’s because the IRS treats debt that is forgiven by the lender as taxable income, which means it is subject to ordinary income tax. Under this scenario, the seller’s taxable income is based on the amount of the sale proceeds – less the money the seller still owes on the property. This scenario can come about if the homeowner borrowed against the residential property and then used those borrowed dollars for purposes other then for improving the subject property.
 
One way around this danger is to assert that the seller was rendered legally insolvent as a consequence of the short sale and therefore there was no money made from the transaction for which to tax. This will require proving that your debts, after the short sale transaction in total, are greater then the value of your total equity. A competent tax attorney might be helpful to the seller in proving insolvency.
 

Short Sale Not Always The Solution

 
Always remember negotiating a short sale is never an easy process. Banks and mortgage companies will only permit a short sale if they can make more money on the short sale then they would otherwise make on the foreclosure.
 
Finally, the best option for the struggling homeowner is to find a way of staying in the home. Some lenders, but not nearly enough, will agree to modify the loan in an effort to give the homeowner more time to stabilize financially and be in a better position to resume making full house payments. Another option is for the seller to insist that it produce the original deed before it can legally foreclose on the property. Most lenders will be at a loss to produce the deed and therefore unable to complete the foreclosure process. Sometimes, the homeowner can forestall foreclosure for years while they save money to relocate and transition out of there challenging circumstances. 
 
Some lenders are willing to make concessions to the homeowner rather than having to foreclose on the property. Banks neither want to assume responsibility for vacant homes nor are they interested in leasing or managing the properties themselves. In the meantime, the longer the house sits vacant, the lower the property value sinks and the more difficult the home becomes to sell.
 
Finally, consider carefully that negotiating a short sale is never a fast or simple process. Banks and mortgage companies and other lenders will only permit a short sale if they know that they can make more money on the short sale then they would otherwise make on the foreclosure. Sadly, no one has ever accused banks or mortgage companies of having too much compassion for their customers. They are in the business to make a profit – no more.
 
For more on short sales, foreclosure, loan restructuring, loan modifications, and seller financed lending, go to GotTrouble.com
    
 
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