Definition
A short sale in real estate is an arrangement between a borrower (mortgagor) and a lender (mortgagee) where the mortgage obligation is settled with a payment that is less than the total outstanding principal balance. This process commonly occurs when a homeowner faces financial difficulties and cannot maintain mortgage payments, risking foreclosure. The forgiven principal is treated by the IRS as taxable income to the borrower.
Key Points:
- In a short sale, the homeowner sells the property for less than what is owed on the mortgage.
- The lender must agree to the short sale and accept a lesser amount as the debt settlement.
- The IRS generally considers forgiven debt as taxable income to the borrower.
Examples
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Residential Short Sale: The Browns fell behind on their mortgage payments, owing Hometown Bank $160,000. To avoid foreclosure, they proposed a short sale. An investor named Stevens offered Hometown Bank $140,000 to settle the debt and then paid the Browns $150,000 for the property’s title. Hometown Bank accepted the offer to save costs related to foreclosure.
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Investment Property Short Sale: John owned a rental property valued at $200,000, but he owed $250,000 on the mortgage due to a market downturn. He couldn’t sell the property for its mortgage value and couldn’t sustain the payments. The lender agreed to a short sale where John sold the property for $200,000, and the lender forgave the remaining $50,000 balance.
Frequently Asked Questions (FAQs):
Q1: What is the impact of a short sale on my credit score? A: Although a short sale is less damaging than a foreclosure, it can still negatively affect your credit score, potentially lowering it by 85-160 points.
Q2: Do I need lender approval for a short sale? A: Yes, the lender must agree to accept the reduced amount as full settlement of the mortgage debt.
Q3: Is the forgiven debt in a short sale taxable income? A: Generally, the IRS considers forgiven debt as taxable income, but certain exceptions and relief programs may apply.
Q4: How long does the short sale process take? A: The short sale process can take several months, typically between 90 to 120 days, depending on the lender’s procedures and documentation required.
Q5: Can I buy another home after a short sale? A: Yes, you can buy another home after a short sale, but lenders typically require you to wait two to four years, depending on your creditworthiness and the type of loan you are seeking.
Related Terms
- Foreclosure: The legal process by which a lender repossesses a property due to the borrower’s failure to meet the mortgage obligations.
- Principal Balance: The outstanding amount of the loan, excluding interest.
- Mortgagee: A lender in a mortgage loan agreement.
- Mortgagor: A borrower in a mortgage loan agreement.
- Debt Settlement: An agreement where a borrower repays a portion of the owed debt, and the lender forgives the balance.
- REO Property (Real Estate Owned): Real estate that a lender, typically a bank, owns after an unsuccessful sale at a foreclosure auction.
Online Resources
- Investopedia: Short Sale Definition
- IRS Topic No. 431: Canceled Debt – Is It Taxable or Not?
- Consumer Financial Protection Bureau: Help for Struggling Borrowers
References
- “The Book on Negotiating Real Estate: Expert Strategies for Getting the Best Deals When Buying & Selling Investment Property,” by J Scott and Mark Ferguson
- “Short Sale Fundamentals,” by Samuel Coates
- IRS: “Publication 17 Your Federal Income Tax”
Suggested Books for Further Studies
- “The Big Short: Inside the Doomsday Machine” by Michael Lewis
- “Real Estate Short Sales Step by Step: A Homeowner’s Guide to Hope, Financial Freedom, and Relief” by Reggie Brooks
- “Short Sale Savvy: Everything Realtors Need to Know About Short Sales” by Chris Birk
