What is a Short Sale?
A "short sale" occurs when a Lender agrees to release its interest in the title to real estate less than the total balance owed. In this way, real estate can be sold and the Lender gets a cash pay off.

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Why would a Lender agree to a short sale?
Lenders are in business to make money and keep down losses. When a Borrower gets behind on their loan payments, the Lender has the right to take the property to pay off the debt. However, in today’s real estate market, many properties cannot be sold for the full amount owed against them. It is possible to persuade Lenders to take less than the full amount owed if the Lender believes that it will make more money though a short sale than through a foreclosure.

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So is a short sale a win-win for everyone?
Well, the Lender is relatively happy, because they have resolved the bad loan and kept down their loss.

The Buyer is happy, because he bought the property for less than someone else paid for it.

The Realtor is happy, because he earned a commission.

The Seller is happy, because he has saved his credit and kept a foreclosure off of his record.

So all is well, for a while, but as this nightmare progresses, it might lead you to consider suicide!

If you are the Seller, do you realize the lender only released the title to the property? Do you understand that you still owe the Lender the balance on the original loan? Do you know that even though the property has been sold, the Lender can still sue you for the balance you owe?

Whether you realize it or not, owing this money damages your credit score.
When you receive a notice from the Lender saying that they are "forgiving" the debt, you think "that's great!"

By "forgiving" the debt, the Lender has not engaged in an act of compassion or charity. Instead, the Lender has taken a tax deduction and given you a horrible tax consequence.

If you don't appreciate the nightmare of this tax consequence right away, your bad luck will only get worse. When you fail to include this debt on your next tax return, the IRS computer will automatically select you for a tax audit. The interest and penalties on the amount you owe as a result of an audit can easily double your tax debt.

Do you find this hard to believe this nightmare is happening to you? Everyone does! You may want to blame someone, but blaming will not pay the IRS debt, which will be enormous. It is impossible to believe that the IRS considers the money you lost on the sale of the property is money that you EARNED! This is really kicking you when you are down.

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So how bad are the tax consequences?
Unfortunately, they are very bad. Here is how you can do the math to estimate the amount you might owe the IRS if you have a short sale. Take the total amount you actually earned during the year you lost the property. Add that amount to the amount you lost in the short sale. If the total is below $31,850, the tax will be 15% of the amount you lost. If the amount you lost brings the total to more than $31,800, then the tax on the amount you lost will be 15% of portion that is under $31,800 and 25% of any amount over $31,800. If the total is more than $77,100, you will owe the IRS 28% of the portion above $77,100. The percentages go higher as the total amount increases.

So, if you had earnings of $30,000 in 2007, and sold your property for $50,000 less than the amount you owed, the breakdown would look like this.

Further information on this issue is available on the IRS web site at http://www.irs.gov/individuals/article/0,,id=179414,00.html

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Is there anything that you can do to prevent having to pay this tax liability?
Yes, as IRS explains on their web site, you prevent this problem if you file Bankruptcy. But you must file before the Lender forgives the debt. If you wait to file until after the Lender has issued the certificate forgiving your debt, you may be too late. On December 20, 2007, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 which allows some taxpayers to avoid the tax penalty as a result of a forgiveness of debt. This act only benefits those whose mortgage was taken out to buy, build, or improve their home. So if you took out a second mortgage to pay off old debts, you won't qualify for this help. If the debt is from rental property or for a second home, you won't qualify either. Mortgage forgiveness will continue to be a tax nightmare for most property owners in Nevada.

Very few people are in the position to pay a large tax debt that unexpectedly comes up. After all, you just had to give away your property because you couldn't make the payments. You probably don't have a lot of extra cash or access to low-interest credit. Once you owe income taxes, the interest and penalties will quickly increase the amount you owe. In most instances, you will not be able to eliminate this tax debt through Bankruptcy for several years. Other options, such as an "Offer in Compromise" may be available to reduce the tax you owe. No other option is as inexpensive or as certain as filing Bankruptcy before the tax liability occurs. Owing large amounts of income taxes completely devastate your credit and it will be years before you are able to do anything to rebuild it.

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What if I lost the property through foreclosure instead?
If you lost the property through foreclosure, you would not have to pay taxes on the money you lost on the first mortgage. But if you had a second mortgage, you would still owe that debt, and you would either have to pay that debt or have the debt be "forgiven", resulting in tax consequences. Again, Bankruptcy would still be an option to prevent you from having to pay this tax liability if you file before the Lender sends you the certificate forgiving your debt.

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