Short Sales: A Real Estate Disaster Waiting to Happen

11 Sep Short Sales: A Real Estate Disaster Waiting to Happen

Distressed homeowners are sometimes approached by real estate agents who tout the idea of doing a “short sale” of the real estate. A short sale is one in which the sale price is insufficient to completely pay off the balance owed on one or more of the mortgages upon the property.

Normally, a lender will not be willing to provide a satisfaction of the mortgage, unless the mortgage is to be completely paid off at the closing. However, if the property is simply not valuable enough to be sold for a price which pays off the mortgage, the lender might desire to cooperate in a short sale, in order to avoid the expense, and delay, of a foreclosure.

A lender will be likely to agree to a short sale only where the homeowner appears to be unable to continue making payments on the mortgage, and only where the property’s value is less than the mortgage balance or balances.

What’s wrong with doing a short sale? Plenty! 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.

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Craig W. Andresen is a consumer bankruptcy lawyer in Bloomington, Minnesota, with 22 years’ experience in consumer and small business bankruptcy cases. He is the Minnesota chair of the National Association of Consumer Bankruptcy Attorneys, and is a member of the Minnesota State Bar Association’s Bankruptcy Section. Mr. Andresen lectures often on the topic of consumer bankruptcy at local and national legal seminars.
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