In the state of Florida and in some other states, a relatively new technique of selling "over-borrowed" real estate has evolved, known as the "short sale". I find, however, that many people are not aware of the short sale and do not know what it is.
The short sale is beginning to be used instead of foreclosure in cases where the owner is "upside-down" in the property, meaning that the real estate, a home, for example, will not sell for what the loan balance is. As an example, an owner has a loan balance of $105,000, BUT the owner cannot get a sale of the property over $86,000. The owner negotiates with the lender to "short" the lender by $19,000 in this case. Although the lender takes this loss, the lender avoids the costs of foreclosure and sale costs. Lenders do not like to own real estate!
For the owner, however, as nice of a rescue as the short sale might seem, there could likely be a pitfall for the owner. In the above example, the shorting of the lender by $19,000 is termed "cancellation of debt". That $19,000 that the borrower is not paying back is likely to be considered by the IRS to be income to the borrower, and the lender will be sending in a IRS Form 1099-C. As with everything else, there are certain situations that are exceptions, including "Insolvency" of the borrower. Insolvency occurs when the total of all debts exceeds the value of all of one's assets. In this case, all or some of the cancelled debt may not be considered by the IRS to be taxable. Regarding the IRS, however, insolvency can be pretty tough to prove.
The short sale can be a terrific solution to a difficult selling problem, but real estate professionals and their "upside-down" owner clients are well-advised to seek the counsel of a tax attorney, CPA, or qualified tax preparer.
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