Donna Bigda in her blog post Foreclosure Vs Short Sale looks at it from the point of view of credit issues and employment. It is a good blog. However, I think we did not discuss one issue with short sale, which is money, and often have more immediate affect on our life than issues with future credit and even employment
I used to think that short sales were unequivocally better solution than foreclosure. Imagine my astonishment, when a client refused to sign a very good offer on his short sale, and withdrew the Listing for 3 properties.
I could not believe my ears when he said that foreclosure works better for him. Here's the kicker. With short sale you got income. It is another story whether you would have to pay IRS or would be forgiven, but there is income. My client does not have either of the 2 options on any of these homes. None of them was a primary residence, and they might have hard time proving insolvency.
I have already heard about a distraught Seller, who want to sue the agent for not telling them that they might have to pay tax on the income as a result of short sale. How many times people later find out that short sale closing was not the end of it? Rather their next year taxes are.
The amount of money that the properties can sell for is seriously less than what he paid for it, and this will create a sizable difference. He called IRS and they told him he would have to pay tax. He went to a CPA and got the same answer. On 3 properties he would run such a sizable taxable income, that it will kill him. He does not have the money, and it would be tens and tens of thousand dollars.
So he decided he would go through foreclosure. He is self-employed, and even if the Lenders obtain deficiency judgments, collection is another story. If they would not be able to collect, they will sell the debt, and then he could negotiate, but if he does, then he would have the same problem as settlement will immediately trigger tax, as the amount that you did not pay back is your ordinary income for IRS.
But if he declares bankruptcy, the Lenders would be able to foreclose, but the only recourse would be the amount that they will be able to recover in the foreclosure sale, or REO sale, and they won;t be able to go after him for any deficiency.
If this scenario is true, then, yes, his credit will be damaged beyond repair for quite some time, but he will avoid the tax to IRS.
I am not saying that this is an optimal scenario, and it will work for everyone, but we, as agents, should be very careful to cheerfully tell our customers that Short Sale is the obvious choice. It may not be in some situations.
So, we need to tell them that Short Sale means income to them, and if they have neither used the property as primary residence for 24 months out of the last 5 years (I hope this provision has not changed), or can claim that they were insolvent at time of Short sale (and they better consult an attorney or their CPA if they can, as it is not always cut and dried), they may better talk to an attorney, who can advise them on the best course of action. Then, if he tells them that Short sale is the way to go, you take them from there.
Let us not assume that we know the answer, when we don't.