What Is A Short Sale?
__________________________________________
Home sellers should consider a Short Sale when the value of their home is LESS than the amount of their outstanding loans. For example, if your home is worth $250,000 but you have a loan of $260,000 then a short sale is a consideration. Obviously, if you do not have to sell your home, you could wait out the market and hope for a turnaround in real estate values.
However, if you do have to sell your home you basically have three options. First, you can bring cash to the table. In the example above you would sell your home for $250,000 and pay another $10,000 to the lender out of your pocket to pay off the loan on your property. Second, you could let the home go into foreclosure. The lender will go through the foreclosure process, force you out of your home and then auction it off to the highest bidder at a foreclosure or Trustee's auction. The third option is to pursue a short sale. You contact the lender, explain the circumstances and convince them to take less than full value of their loan.
In the case above you may tell them you have a buyer for $250,000 and it's very unlikely there will be a buyer at a higher price. If they will accept $250,000 for their $260,000 loan then you can proceed with a short sale. Sometimes the lender will consider a short sale before you have a buyer and you can market your property and, if you find a buyer, take their offer to the lender for consideration. The lender may or may not accept the offer.
Steps In A Short Sale
__________________________________________
Short sales are not necessarily complicated but do require some work on your part and your agent's part if one is involved.
- Find a buyer and sell your property. The lender will still have to approve the buyer?s offer but once they do you can sell your property.
Why A Lender Would Accept A Short Sale
___________________
While most lenders will not be thrilled at the prospect of a short sale they are acutely aware that a foreclosure is usually a far more time consuming and costly option. In a real estate market where housing values are going down it is in the best interests of the lender to liquidate their problem loans as quickly as possible.
With a short sale a property can be sold and the loan taken off their books fairly quickly. If they pursue a foreclosure they run the risk of the process taking a substantial amount of time during which the value of the property is depreciating. Also, buyers will tend to write low ball offers when they know that a bank or lending institution owns the property. The property will also be left vacant which can result in vandalism and deterioration. Some owners will even gut the house just before the foreclosure sale as a way to 'get back' at the lender. This is illegal but nonetheless happens on occasion. So, you can see why a lender might want to go the short sale route and get the loan off of their books with minimal hassle.
IRS Form 982
___________________
We are not tax experts so what we've written here is only for informational purposes and should be used as a starting point to further investigate the potential tax savings involved. It is absolutely worth your time and money to consult with an expert in these matters as it could save you thousands of dollars.
As we mentioned in another article, 'Beware The IRS', you could be in for a large tax bill if you utilize a short sale, foreclosure, or deed in lieu of foreclosure. The amount of debt that is 'forgiven' by your lender may be viewed as income for that tax year by the IRS. If you owed $450,000 on your home and you received an offer for $400,000 and your lender accepted the offer ( a short sale) then the IRS would view the $50,000 difference as ordinary income in that tax year. So, you would owe taxes on $50,000. This is a simplistic example and most cases are more complex but the bottom line is that you need to be aware of the potential tax liabilities involved in a short sale.
Is there a way to avoid paying that tax? Possibly. IRS form 982 says, "Generally, the amount by which you benefit from the discharge of indebtedness is included in your gross income. However, under certain circumstances described in section 108, you may exclude the amount of discharged indebtedness from your gross income". The specific instructions are contained in section 108 of the Internal Revenue Code.
One of the 'circumstances' they are referring to is that if you are insolvent before you conduct a short sale then you may be able to 'exclude' the forgiven indebtedness (the amount the lender forgave on the loan) from being added to your gross income for that year. Here are some questions you will need to ask an expert:
- Can I avoid paying taxes on the forgiven debt if I was insolvent at the time of the short sale?
- Do I have to file bankruptcy to be considered insolvent?
- If you already used a short sale and paid taxes can you file an amended return and get a refund?
- Does your real estate agent understand any of this?
- Do you have to surrender your property in bankruptcy to be eligible for relief?
- Does a form 982 have to be filed in order to be eligible for tax relief?
-
Beware The IRS!
___________________
Many homeowners do not realize that they may be in store for a large tax bill from the IRS after the short sale of their home. Every situation is different and you should absolutely contact an accountant or tax advisor before conducting a short sale to determine your potential liability.
As an example assume you purchased your home for $400,000 in 2003. Since that time it has appreciated to $500,000 and you refinanced and now owe $450,000. You need to sell your home now but due to the bad market you can only get $400,000 for it. Your lender accepts a short sale since you owe them $450,000 but they are accepting only $400,000. The IRS considers the $50,000 that was "forgiven" by the lender as "debt relief" income.
Your lender will probably send you a 1099-C in the amount of $50,000 and the IRS will want you to pay taxes on that amount. What are the odds that you have that kind of money laying around after you just went through a short sale on your home? Be very careful regarding your tax obligations BEFORE you consider a short sale, deed-in-lieu-of-foreclosure or foreclosure.
The IRS will use your tax basis on your property to determine your tax obligations so you must be able to figure this amount out.
See our article on IRS Form 982. The form is used to request a "reduction in tax attributes" due to insolvency. This may allow you to avoid having to pay taxes on the debt relief you experience with a short sale. Definitely worth talking to a tax attorney or accountant about!
The Short Sale Package
___________________
All of the documentation needed to start a short sale is commonly called a "Short Sale Package" and is usually submitted by the investor interested in the property, the agent representing the seller, or the seller of the property. The package usually includes the following items:
Sample Short Sale Package (items may vary depending upon the lender):
- Cover Letter
- Authorization to Release Information
- Sellers Hardship Letter
- Seller's Financial information
- 2 years w2's
- 2 months pay stubs
- 2 months bank statements
- Supporting Hardship Info - HOA liens, medical/disability statements etc.
- Repair Estimate for the property
- Comparable sales for the property
- Contract
- Net Sheet
- First mortgage holder may ask for a payoff amount from the 2nd
- Second mortgage holder may ask for a payoff amount from the 1st
- Lender may ask for an Initial Title Report
- FHA and VA may have their own forms and special requirements as well
The Hardship Letter
___________________
The Hardship Letter is usually part of the short sale package and is written by the seller or their representative. It is used to explain to the lender the reasons for the borrower's need for a short sale. Reasons such as divorce, job loss, medical issues, etc. can and should be included. Usually just a one page letter with the pertinent information will suffice.
A simple letter in the following form should suffice:
Date
Lender Name
Address
Loan Number
Dear Sir/Maam,
{In this section explain your hardship and why you must utilize a short sale - some example hardship reasons are listed below}
- Unemployment
- Reduced Income
- Divorce
- Separation
- Medical Bills
- Too Much Debt
- Death of my Spouse
- Death of a family member
- Payment Increase
- Business Failure
- Job Relocation
- Illness
- Damage to Property
- Military Service
- Incarceration
- Other (Please Specify)
Borrower's Signature
Date
Co-Borrower's Signature
Date