What is a Short Sale?

We are hearing a lot more these days about "short sales" and a common question is just exactly "What is a Short Sale?" Ever since the market began to adjust  downward in the Summer of 2005, short sales have become more common.

So what exactly is a short sale? It's actually quite simple: it's the sale of a property where the value of the property is LESS than what is owed on it. In other words, the price obtained from selling the property is NOT enough to pay off the loan(s). However, with a short sale, the lender(s) do, indeed, take less just to ensure they don't lose even more money later, or end up having to foreclose of the property. Two of the most common reasons homeowners get into this situation, where they owe more than the property is worth, is 1) they bought the property at the peak of the market with very little money down; and 2) they refinanced and "max'd" out their equity to buy other things. In both of these situations, when the market softens as it has over the past two years, and the value of their property drops, they end up owing more than it's worth.

So, if an owner needs to sell (and keeping the property is not an option), and they don't have enough equity to cover the selling costs and pay off the loan(s), they have only a few choices: 1) pay the difference out of their own pocket (the ideal option); 2) let the bank take the property back through foreclosure (the worst option); or 3) do a short sale (still not the greatest option, and a serious ding on the seller's credit report). For a bank to allow a short sale and take less than they are owed, an owner must demonstrate they have a true hardship (serious financial problems that prevent them from keeping the property and paying the difference at the time of sale). If they can't show a legitimate hardship, banks often won't consider a short sale.

In addition, although most people are unaware, there are tax consequences when you do a short sale. If a bank allows the seller the debt relief (took less than was owed), the IRS looks at the amount of relief the same as income, and taxes would be due on the amount of relief. For example, if a seller owes $400,000 to the lender and the home sold for $350,000 (selling costs are not included in this example to keep it simple), then the seller got $50,000 of debt relief. The seller would then owe taxes on the $50,000, not to mention the serious repercussions on their credit rating. Of course, my best recommendation for anyone considering a short sale is to consult with their CPA and/or tax advisor.

The best way to avoid a short sale, of course, is to keep the property until values head back up, And, historically, they eventually always do.

Also see:

• Can You Really Sell for LESS Than You Owe?
• Buying a "Short Sale" Home

Comments

[Bend Houses for sale]

Short sales are looking even better right now. I noticed the inventory is raising locally. Might be a good thing for investors.

[b nolan]

I've recently heard that congress has made a change and that in certain circumstances there are no longer tax consequences with a short sale. What are the new perameters? Thanks.

[Jon C.]

Many people are looking at real estate short sales as an exit strategy. A short sale should be a last resort to avoid foreclosure but because so many markets have dropped significantly, a homeowner's only option when needing to sell is a mortgage discount.

[John Beck]

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