Quoting from the above link:
You may be able to exclude cancelled debt income if all or part of the debt was discharged in bankruptcy; you are insolvent; or the debt is a qualified farm debt. Refer to Publication 908 (PDF), Bankruptcy Tax Guide, and Form 982 (PDF), Reduction of Tax Attributes Due to Discharge of Indebtedness for more information.
Posted by DavidCAL on October 19, 2003 at 18:11:03:
I’ve bought a few foreclosures in California, but I have never done a short sale and I’m curious about a couple things.
Are these mainly a last resort when you have a guy who’s nearing his sale date and has no equity? And, as I understand it, the bank always wants to see that the borrower is not getting anything from the transaction. So, why would a person do this, other than to salvage a piece of their already trashed credit?
Wouldn’t it be smarter for the person to just stay in the property for a few more rent-free months? How do you sweeten the deal for the Seller?
Short sales are not necessarily a last resort thing, they are the first thing I do when I get a foreclosure. Most of the time the sellers don’t have a lot of equity. Some of them have a bit. If they have too much, most likely the lender is not going to short sale their mortgage considering their loan to value ratio is great enough for them to take the property back and recoop their expenses. You are right, though, lenders do not want to “see” the seller getting anything, and your HUD-1 will reflect that. That just means the seller is not getting any money out of the proceeds from the closing. There is no law that says you can’t buy something from the seller, or something of the like. I always give my sellers at least 1k for moving expenses, but hey I like to help people. Also, it is certainly not smarter to just stay in the property and do nothing. If you help them, there will be a dismissal filed in the public records instead of a foreclosure. Just one small advantage for instance.
What do you tell the homeowner when they get a 1099 from the lender for the difference in what they owe and what the lender accepts as a payoff? I’m meeting with someone to offer to solve her problem with a short sale but I’m stumped to answer that question.
Posted by DavidCAL on October 20, 2003 at 21:20:20:
Thanks for the info. Would you go for a short sale here?
The market is still hot out here in CA. I’ve got a lady with a condo who owes 80K on a first trust deed and 5k in HOA fees. She won’t take less than 5k to move and the place needs no work (I’m not sure if she has anything I can buy from her for cash). She just stopped foreclosure with a ch.13. Comps range from 65k to 95K, but I happen to know the area and know it will go for 125k (an identical one in her complex just went into escrow with a full price offer at 125k after 6 days on the market).
What happens if it goes to the auction and it sells for less than what is owed on the house and they get a deficiency judgement that way, or they take it back and don’t resell it for enough? However, both of these scenarios are as unlikely as yours. Most lenders are not going to come after the borrowers for the difference, especially when the deficiency is not going to be that great, unless you’re dealing with a higher-end property. But you do have to let your seller know that the lender may or may not come after them and that you have no way of knowing if they will or won’t.
Yes, I would try a short sale. It doesn’t hurt to try. If it is now in bankruptcy, you’ll have to get the trustee to release the property for the sale. If you have low comps to show the lender, that will help. The assoc. lien you might be able to get released or negotiate down. Did the assoc. get a final judgement filed? If they did there will be a statutory amount that they will get from the sale, so you may have to at least match that. 5k seems like a lot to give your seller. How long has she been in the property? Why is she in foreclosure? Does she know about the 125k sale? What did she pay for the place? How much equity does she feel she has? Do the math in front of her. She owes 80k, plus another 5k lien, plus closing costs etc., plus she wants 5k. What does that leave you? But, if you don’t have any problem paying her 5k, I don’t either. Does the property have a dishwasher, range, refrigerator, water heater, etc.? These are all things that you can “buy” from her.
Coming after you through the judicial system via a deficiency judgment.
Sending you a 1099 for taxes so that they can legitimately write off the reduced sale price from a foreclosure or a payoff of the loan via a short sale for less than what was owed.
I agree with you that the first is unlikely, however, I’ve read in the archives that the lender is forced to send you a 1099 if they want to legally write the bad debt off. So the seller is taxed on the difference as if it were a gain. This could be stiff if they accept a large loss. For instance, a $50k loss by the bank goes as a $50k gain on a 1099 to the seller. At the minimum, I’d state in my contract that they should seek competent tax advice and that I don’t offer any…I’m just a buyer. I was just wondering if someone has a better answer to the tax question from a seller.