SHORT SALE: FEES, CREDIT & TAX CONSEQUENCES
By: Roman P. Mosqueda, Esq.
Real Estate Broker & Attorney
You are unable to sell your residential or commercial property to a third party buyer, or refinance it, because it has insufficient equity.
You have borrowed too much on your property, the value of which did not increase, or worse, even decreased; or you simply cannot find any ready, willing and able buyer.
You are unable or unwilling to pay any loss to your lender(s) to be able to sell or refinance your secured property.
You are behind in your payments by at least three months. Pursuant to the deed of trust (security instrument), the trustee (usually a title company) sends you a Notice of Default on your loan.
The Notice of Default states the amount in arrears, and gives you ninety (90) days to cure the default by paying all the late payments, penalties and costs.
After expiration of ninety days, your lender files a twenty-one (21) day Notice of Trustee’s Sale to be conducted by auction. You have until five days prior to the sale to make full payment of the entire balance.
You get a proposal in the mail from a company or person for you to transfer or deed your property and pay an upfront fee (may be a flat rate or percentage of your original loan balance) to it or him/her, who will negotiate a “short sale” or allow a foreclosure.
Foreclosure:
A short sale or short payoff exists when the lender releases its collateral interest in the secured property, for less than the full amount owed on its obligation, to accommodate a sale of the property to a third-party buyer, or to refinance the property through a third-party lender.
In other words, short sale is getting a lender or bank to accept as full payment less than the entire balance of a loan.
Several reasons motivate a lender to accept a short sale or short refinance, to wit:
1. avoidance of foreclosure, its costs, and of sale of a foreclosed (REO) property;
2. early reinvestment of recovered payment funds through short sale or refinance, rather than through foreclosure; and
3. removal of the distressed loan from non-performing loan status that adversely affects the lender’s reserve requirements.
Short sale or short refinance, whether done by the homeowner-borrower or through a company or a person purporting to acquire and dispose of properties without equity, has some pitfalls.
Adverse Information
In Credit Report:
The typical modus operandi of a short sale is the transfer of a property by deed to an entity or third-person who will negotiate the short sale, or allow a foreclosure.
There are companies who do short sale negotiations for a stated upfront fee or a percentage of the loan balance, and who commit unfair business practices, such as fraudulent schemes involving milking money from the property, rent skimming and bankruptcy law abuse.
And in case the lender does not agree to the assumption of your loan by the company or entity or person that acquired your property, that is, the lender does not regard the transfer as a bona fide sale, then it will continue to collect payment of the debt from you.
Consequently, any late payment(s) and foreclosure reported by your lender to the credit reporting agencies become part of your credit record, not that of the company or entity or person to whom you deeded the property.
In some instances, such a company, entity or person may provide a letter to the credit reporting agencies or future lenders that a homeowner was not the owner of the property at the time of default, foreclosure and/or deed in lieu of foreclosure.
Such explanation of derogatory entries in a credit report is allowed, but its acceptance diminishes in value in proportion to the prevalence of its use by unscrupulous, short sale-service entities or persons.
Tax Consequences
Of Short Sale:
Some short sale-service companies represent that a homeowner’s tax liability in case of a short sale is based on the difference between the fair market value of the home and the balance of the loan on it.
And they also represent that in case of a foreclosure, a homeowner’s tax liability is calculated on the difference between the loan balance on the home and the amount of the purchase price after foreclosure.
But neither the fair market value in case of short sale, nor the later selling price in case of foreclosure, is considered in the calculation of tax liability.
Indeed, tax liability is calculated on the difference between the purchase price of a home plus improvements less depreciation and any deferred gain on the sale of any previous home (which is the tax basis of a home) and the amount owed on it at the time of the short sale or foreclosure.
So, a homeowner may owe tax, or may not owe tax, depending upon the circumstances. If a homeowner owes less than he/she paid for the home, regardless of present value, he/she may not owe any tax at all.
But if a homeowner owes more than his/her tax basis, he/she may owe taxes after short sale or foreclosure.
For example, you bought your first home, and later sold it at a profit of $100,000, you rolled over that gain into your second home, with a purchase price of $500,000 and a mortgage (deed of trust) of $250,000.
With this rollover, your tax basis is $500,000 less $100,000, or $400,000, and not the purchase price of $500,000. A foreclosure by your lender is considered a sale at the price of the balance on the loan of $250,000.
So, you owe less ($250,000) than your tax basis ($400,000). You may not owe any tax. But if you owe more (if your loan balance is $450,000) than your tax basis (for example, $400,000), then you may owe taxes on the difference of $50,000.
In a short sale, a homeowner may often have tax liability if the mortgage debt exceeds the tax basis, and no tax liability if the mortgage debt is less.
Beware of a short sale. It has its shortcomings.
(The Author, Roman P. Mosqueda, has been a Real Estate Broker since 1999; and a Real Estate Attorney since 1984, in California. He was a practicing Real Estate Broker and Attorney in New York City before he moved to California in 1983.)