Thursday, October 23, 2008
A short sale is an arrangement between a homeowner and their lending institution to accept an offer on the home for less than the total amount owed on the property. A bank-owned house, or foreclosure, is not a short sale. A seller deciding to lower their price and take less profit is not a short sale. To have a short sale, one of the parties has to be “shorted”; either the seller or the bank.To further explain the difference; with a typical foreclosure situation, homeowners fall behind in their payments and the bank repossesses the house and sells it. In almost all cases, the bank pursues the homeowner for the deficiency (the difference between the amount owed and what the bank collects at the short sale). The only real way out of this type of situation is to file bankruptcy.In the case of a short sale, a homeowner owes more for their house than they can sell it for. In other words, they are upside down. With a short sale, the owner goes to the bank and tries to arrange for the lender to forgive the difference.
What about the Deficiency?
Because of the large and growing problems with homeowners defaulting on their loans, the rules about short sale deficiencies have changed. Previously, the deficiency could be 100% loaned to the seller in the form of a promissory note which would have to be repaid. If the bank wrote off any portion of the deficiency, this would be reported on the owners 1099 as income. New and important tax rules have changed this! If the home that is the subject of the short sale is a principal resident – vs. an investment property – and that home is worth less than or equal to $2 million, the tax on the deficiency will be forgiven. This is huge.There are four criteria a homeowner must meet to qualify for consideration by the lender for a short sale.is an ac
ceptable Hardship?
Examples include:What is the Insolvency Requirement?The owner must not be able to pay down their mortgage. To qualify for a short sale, the homeowner must be financially insolvent. This means that they owe more than they have and they do not have liquid cash or assets that could be used to buy-down their mortgage.
If the owner does have liquid cash or assets they will be expected to use them to pay down their mortgage. There could be a scenario where an owner made a contribution towards the sale of the property and the lender covers the shortfall.
A short sale is not a way to get out of a mortgage. It is a tool for a borrower to use when they truly can’t pay their mortgage.The major difference is that a foreclosure is a credit item that can last forever and a short sale is not.Prior to 2007, a homeowner would receive a 1099 for any debt that was forgiven in a short sale or a foreclosure. In effect, the cancelled debt was considered income. The Mortgage Forgiveness Debt Relief Act of 2007 changed this rule.From January 1, 2007 to January 1, 2010, the tax on debt cancellation in a mortgage discharge situation is eliminated if the debt was incurred in the acquisition of a principal residence and he cancelled debt is less than or equal to $2,000,000.Debt from a second mortgage or HELOC is not eligible nor is cancelled debt from investment properties and second homes.