Tax Implication of a 'Short Sale' - John R. Dundon II, Enrolled Agent
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Tax Implication of a ‘Short Sale’

Tax Implication of a ‘Short Sale’

A new term that has entered the mortgage loan industry in recent years is a short sale. Simply put, a short sale is a sale of real estate in which the sale proceeds fall short of the balance owed on the property’s loan.

This answer to homeowners underwater occurs when a borrower cannot pay his or her mortgage loan and the lender agrees to a sale of the property at a moderate loss. It saves the lender from foreclosure costs and curtails the damage to the borrower’s credit history.

It can be handled faster than a foreclosure and is less expensive. However, it does not eliminate any remaining balance on the loan unless agreed upon by both the lender and the borrower. Most large banks or mortgage companies have loss mitigation departments that evaluate the proposal to determine if it is in the best interest of the lender to participate in such an arrangement. The lender will determine how much equity is available (if any) by the use of a broker’s price opinion or an appraisal. Due to the present overwhelming number of underwater homeowners, lenders are more amenable to accepting short sales than previously.

These short sales differ somewhat from a foreclosure in that a foreclosure is an action taken by the lender. In a short sale, both parties must agree. A buyer of a short sale property may be in jeopardy due to either the lender or the borrower changing his mind at any time prior to the execution of the deed.

Adverse credit implications of a short sale are significantly less than that of a foreclosure. According to the Distressed Property Institute, short sales do not show on a credit report. If the borrower is current at the time of the sale, a new mortgage is possible one to three years after a short sale. Compared to a foreclosure in which a credit score can be affected by as much as 300 points, the short sale is a better option. A foreclosure will remain on the credit report for as long as ten years and is permanent in the public records of the county in which the property is located.

An employer, whether present or in the future, has the right to check credit if you are in a particularly sensitive position. A foreclosure is one of the most negative items on a credit report and could affect any future employment. On any federally-mandated standard loan application, you are asked specifically if you have had property foreclosed on or given title or deed in lieu of within the past seven years. This affects the interest rate given on any future loans.