Short Sale vs Foreclosure May Not Always Be A Winner

By
Real Estate Broker/Owner with Daytona Condo Realty, 386-405-4408

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.

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Jon Zolsky, Daytona Beach, FL
Daytona Condo Realty, 386-405-4408 - Daytona Beach, FL
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Bill - this is where the problem is. We tend to pick one aspect and try to monopolize it. As if our brain can't hold more than one notion.

Apr 28, 2009 05:35 PM #24
Rainmaker
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Martin Kalisker
Greater Boston Association of REALTORS - Boston, MA
Professional Standards & Legal Assistant

I don't understand this.  It is not the job of the Realtor to provide tax advise on the treatment of loan foregiveness.  So how can he be sued (unless he did in fact over step his boundries)?  Also, there is federal legislation in effect until December 31, 2009 under the housing stimulus package that may exempt "deemed income" from a loan modification or short sale.  However, state income taxation could be different.  Such is the case in the Commonwealth of Massachusetts.

It is up to the lawyers and tax advisers to properly understand the tax treatment of the loan foregiveness or modification, not the Realtor's.  It sounds like someone dropped the ball on this one.

Apr 29, 2009 03:00 AM #25
Rainmaker
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Lyn Sims
RE/MAX Suburban - Schaumburg, IL
Schaumburg IL Real Estate

Totally agree with you.  I disagreed with quite a few suggested points on the post you mentioned.  Each case has to be done individually and WE as realtors, shouldn't be the ones doling out the information on what is best. Attorney, tax accts, etc. NOT REALTORS.  There was also an incorrect mention of what a short sale or foreclosure will do to your credit.  Well you can bet your last 10 cents that with all the short sales going on the lenders are not going to stand by and let you continue your life without a blemish or ding on your credit report.  That would be unrealistic.

Apr 29, 2009 06:59 AM #26
Rainer
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Kelsey Barklow
Hurd Realty - Johnson City, TN
423/948-9154

We, as Realtors, should strongly suggest that our sellers consult a qualified professional, i.e. lawyer or CPA, to guide them in this difficult process and if they decide to pursue a short sale, they should then consult with another qualified professional, a Realtor who has at least a few successful short sales under their belt.

Apr 29, 2009 12:14 PM #27
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Jon Zolsky, Daytona Beach, FL
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Sidney - My guy is saying that he is self-employed, and he does not see how anyone can collect. Unless there is an easy way to collect from him, he might have a point. Is it looking to the future? Not much. But he is 60 yo and he does not care for the future, at least that what he is saying

Apr 29, 2009 03:55 PM #28
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Ron - I am asking this question, so I will let you know what the answer is. Good question, by the way

Apr 29, 2009 03:56 PM #29
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Sharon - you are correct. Thank you for the comment

Apr 29, 2009 04:12 PM #30
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Mike - of course. And each situation is different.

Apr 30, 2009 06:23 PM #31
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Jon Zolsky, Daytona Beach, FL
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Tom - sometimes you can only make them talk to a professional after you give them some scenarios that they do not even think of, and that makes some people get serious, and not just "let's do it, and then see what happens".

Apr 30, 2009 06:24 PM #32
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Gene - exactly. We need to be as versed as we can be, but there is always more to that that we may know. Can't gamble

Apr 30, 2009 06:26 PM #33
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Roger - I actually used your comment for my next blog. I have to say "thank you" to you for that. I think that though I unsderstand your point, and there is no question that this is a valid concern and valid point, there is another side to that. There is a communication with the customer.

We have to maintain the communication, and this is our best chance to show our experience, our knowldge, and I think we need to take full advantage of our familiarity with the issues, even if they are not our core expertise. We still can discuss a lot of issues and then advise the customers to get the professional advice from an attorney, or accountant, however, this would put us in a position of knowldgeable people who are with customers all the way

Apr 30, 2009 06:30 PM #34
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Jon Zolsky, Daytona Beach, FL
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David - thanks for the relevant link.

Apr 30, 2009 06:32 PM #35
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Jon Zolsky, Daytona Beach, FL
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Jennifer - this was funny. Isn't it like driving. We already can drive, and then there is a turn and all hell goes loose and we are in trouble.

Being able to drive is a skill. Knowing that the situation can change in a split second and be ready to stop on a dime is the closest to wisdom.

Apr 30, 2009 06:35 PM #36
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Wendy - that is an excellent comment. State laws differ. You also showed something that I did  not know and did not suspect before: that having the property as primary residence does not automatically mean that you have no tax ramifications.

This is what I like about AR. Someone with knowledge and good eye would pick the thread and add to the discussion. I am very grateful to you for doing it. Interestingly, I did not run into that in any of the numerous discussions of short sales.

I did not check, but if you have not written about this, you sure should. It is very important, and it may save a lot of agent the trouble later, when the tax time comes.

Thank you

Apr 30, 2009 06:43 PM #37
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Martin- the Seller was not advised by the agent that there might be tax ramifications. The Seller in short sales very often does not want to go to the attorney and pay for that. They do short sales because there is not enough money, or no money at all.

Often times the Seller would have turned to the attorney only IF the agent have told them that they better do it. I this case the agent told the guy that he could help him do the short sale, and he did. The surprise came a year later, when the tax time came.

Even though we are not attorneys and/or tax professionals, we can and should create the awareness of potential issues, that may be compelling enough for the customers to seek professional advice.

Apr 30, 2009 06:51 PM #38
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Lyn - absolutely. Yes, you can walk away, but to walk away with stellar credit?

Apr 30, 2009 06:53 PM #39
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Kelsey - That would be great, but the reality is that many people in short sale situation do not have the money, or are trying to save as much as they can, so they are inclined not to seek professional help. You can't seek professional help if you do not have the money.

Also, we assume that it is that easy. You go to the attorney and you get professional help. It is not. How many attorneys really know short sales? And if you go to a bankruptcy attorney, are you surprised that you would end up in bankruptcy even if you could avoid it?

Apr 30, 2009 06:56 PM #40
Rainmaker
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Palm Coast Homes
100 Plus Realty LLC - Palm Coast, FL
Palm Coast/Flagler County Real Estate, The Ross/Co

Great post Jon....I am consistently amazed when I speak with people that have received mis-information about short sales from professionals that are claiming to help.  I do a tremedous amount of educating to buyers and sellers about what short sales really are and what they pros and cons are.

Aug 24, 2009 10:04 AM #41
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Hi Kristi,

I see you are back in Palm Coast. Thanks for the compliment.

The issue of the forgiven debt creating income in the eyes of IRS is dangerously confusing to people, and if  they take it lightly, they may be up for a big surprise. You can fight with collection agency, and you can not pay them, and drag for years, but it is much more riskier to not to pay IRS.

I hear sometimes when people say "let's do it one step at a time" meaning that their priority now is with getting a short sale. Well, I am not sure they will be as lightheaded when it would come to the  tax time next year.

Aug 24, 2009 02:06 PM #42
Anonymous
Cindy Greenwald

Hi Jon,

Just to clarify a point, If the seller is not living in the home at the time of the short sale, it is not his primary residence. You can only have one primary residence at a time. The "24 months within the past 5 years" rule does not apply in a short sale situation.

The general message among all agents responding is that the seller needs professional advice from his lawyer and/or CPA. We are there only to guide them through the process. Ultimately it's the sellers decision as to which path to take. I was taught that once the short sale has been approved by the lender and the seller has agreed to the terms set forth by the lender that we as agents should have the seller sign yet another disclosure. It simply states that the seller has been advised by me, the agent, to consult with their attorney and/or CPA regarding this short sale transaction. It was also suggested that we include a box for the seller to check off stating that they have waived this advice! We then go on to say that the seller will hold harmless me, the agent, the broker, the escrow company, title, the mailman, etc  etc. so that everyone involved is covered!! It may not keep you from getting sued, but it will surely help your cause.

Oct 08, 2009 06:05 AM #43
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