What is a short sale? This a term which is being used with increasing frequency in today’s real estate market.
A short sale is when the proceeds from the sale of a home are not sufficient to fully pay off all outstanding debts which are secured by the property (mortgages) after first deducting the homeowner’s costs of selling the property. In such instances, the selling homeowner can either bring funds to closing to make up the difference, or obtain approval from his mortgage holders to accept a reduced amount to satisfy his outstanding loans.
Unless a homeowner is able to pay off all of the mortgages which are secured by his property, the homeowner will not be able to convey good title to a buyer. If the homeowner is unable to obtain a sales price which enables him to pay off all loans and closing costs, and he does not have the funds to make up the difference, then he may want to try to obtain approval from his current lender(s) to accept an amount less than the full amount due on its mortgage. For a lender, this may be acceptable to obtain repayment of a substantial amount of its loan and to avoid the costs and delay of foreclosing on the loan. This will generally mean that the Seller will not receive any funds from the sale of his home.
In order to obtain such approval from a lender – which may or may not be granted – the homeowner needs to contact his lender(s) to determine what information they will need to make their decision. This usually includes a financial statement of the homeowner, copy of a contract of sale, appraisal, and other pertinent documents. Generally, a lender will not consider approving a short sale without a clear economic hardship on the part of the homeowner and an existing default or pending foreclosure.
Until recently, forgiveness of a debt under these circumstances, could trigger a taxable event according to the IRS. This means that if a lender forgave a part of the mortgage debt by accepting a reduced amount in full satisfaction of the loan, then the amount forgiven could be deemed taxable income to the homeowner. This was so even though the homeowner received nothing from the sale. However, in December 2007 Congress passed the Mortgage Forgiveness Debt Relief Act of 2007. This Act amends the Internal Revenue Code to exclude from gross income amounts attributed to a discharge of indebtedness incurred to acquire a homeowner’s principle residence. The amount of the debt forgiveness can be up to $2.0 million. Thus, a homeowner is now able to sell his home for less than what is owed on it without incurring an additional tax liability. This exemption for forgiven debt, however, is only temporary and expires within three years.