Short sales of real property are not for the faint of heart or the uniformed. A short sale is the term given to the situation where a homeowner has a prospective buyer who wants to purchase the home for less than the amount owed to the lender(s) who have liens on the home to secure one or more loans. For example, A owns Blackacre, which he purchased for $300,000 at the height of the real estate boom with a $280,000 loan from Unfriendly Bank. The home is now worth $150,000 and B wants to buy the home at that price, but cannot unless Unfriendly Bank releases its lien on the home for $280,000. A negotiates with Unfriendly Bank until A is blue in the face and has pulled out all of his hair and finally after what seems like an eternity, Unfriendly Bank agrees to accept $150,000 at the closing in exchange for releasing the $28,000 lien. The fact pattern describes a typical scenario that is called a “short sale.”
There are a lot pieces to the short sales puzzle. If you are considering a short sale, you should first do your homework and understand the process from a to z. Here are some issues to understand, consider and resolve before you do a short sale:
- What special provisions should a seller or buyer put into a real estate purchase agreement when the transaction involves a short sale?
- If the short sale is completed, can the lender sue the home owner for a deficiency? In the example above, the lender was owed $280,000, but was only paid $150,000 at the short sale closing. The short fall amount of $130,000 is called the deficiency amount. Borrower promised to pay $280,000 when borrower signed the promissory note and borrower only paid the lender $150,000. Can and will the lender take legal action against the borrower/owner to collect the deficiency amount? For more on this topic, see “Confusion about Short Sales and Arizona’s Anti-Deficiency Law.”
- What are the federal income tax consequences of a short sale? Will the owner/borrower have to report taxable income to the IRS for the amount of debt the owner/borrower is released from paying? The general rule of federal income tax law is when a borrower is discharged from paying all or a portion of a debt, the borrower has taxable income in the amount of the debt that was forgiven. When real estate is involved, the answer to the question can become more difficult to determine. See “Federal Income Tax Consequences of Home Foreclosures & Cancellation of Indebtedness” and the “Mortgage Forgiveness Debt Relief Act of 2007,” which ameliorates the normal foregiveness of indebtedness rules discussed in the former article.
- How will a short sale affect the seller’s credit score?
- Will a short sale create a waiting period before a seller can buy another home?
The good news for people contemplating a short sale of Arizona real property is that the Arizona Department of Real Estate and the Arizona Association of Realtors have worked together to publish an excellent Arizona short sale help booklet called the “Short Sale Seller Advisory.” The introduction to the booklet states
A short sale involves numerous issues as well as legal and financial risks. This Advisory is designed to address some of these issues and risks . . . .
Here are the topics covered in the “Short Sale Seller Advisory:
- Understand a Lender’s Options upon Loan Default
- Be Aware of Predatory “Rescue” Scams & Short Sale Fraud
- Contact a free HUD-approved housing counselor or contact your lender directly
- Utilize free services available to Arizona residents
- Obtain Legal Advice
- Obtain Tax Advice
- Be aware of the Consequences of Committing “Waste”
- Consider All Options such as: loan workout, loan modification, refinance, deed in lieu of foreclosure, work out sale, bankruptcy and foreclosure
- Contact a qualified real estate professional
- Investigate documentation and eligibility
- Determine the amount owed on the property
- Determine the estimated fair market value of the property
- Consult legal counsel
- Understand that a short sale may not discharge the debt
- Obtain tax advice
- Be aware of the impact on your credit score
- Understand that there may be a waiting period before you can buy another home
- Review the Arizona Association of REALTORS® (AAR) short sale forms
For information about the federal income tax consequences of a short sale or discharge from indebtedness income see “Mortgage Forgiveness Debt Relief Act of 2007” and “Federal Income Tax Consequences of Home Foreclosures & Cancellation of Indebtedness.”