A Long View on Short Sales

David A. Holmes, Attorney
David’s practice focuses on asset protection, corporate and business law, civil litigation with an emphasis in contract, commercial and construction disputes, and real estate.

Five years ago the talk at cocktail parties was about money made on the latest hot real estate flip.  Today it seems to be about how much banks are willing to write off, usually in short sale transactions.  Then as now there is more to the story, and things never are quite as easy as others make it sound.

While every situation is different, here are three issues most borrowers should expect to encounter:

1. Default.  Few if any lenders will consider any kind of modification, short sale, or other work-out unless the borrower is at least 90 days delinquent.  That means stopping payments and, if you are the primary borrower, the resulting damage to your credit score, credit accounts, and other financial matters dependent on maintaining good credit.
2. Disclosure.  Lenders will routinely require financial disclosure before considering a short sale or modification—usually in the form of a financial statement and tax returns.  With this information, the lender’s decision will largely be based of whether or not a judgment on the defaulted loan appears to be collectible from the borrower’s other assets.  A borrower attempting to preserve assets can be understandably reluctant to turn over a financial road map to the lender under such circumstances.
3. Income.  Because a short sale or other modification typically includes the lender writing off debt, the lender will be required to report the amount written off as “forgiveness of debt income” to the borrower on IRS form 1099.  This can create significant tax problems.  There are exceptions for a primary residence and strategies for offsetting income with losses, but the tax issues must be considered carefully.

In summary, pursuing a short sale or other modification typically involves choosing among a series of unattractive alternatives—continuing to pay on a significantly devalued real estate asset with little or no equity, or confronting the issues outlined above.  Understanding the costs and benefits ahead of time will improve your decision making process.