As you know, I’ve been searching for a 4-plex to invest in and I am finding that many properties listed are short sales. A short sale is a sale of real estate property where the proceed fall short of the balance owed to the bank. This begs the question, who will cover the monetary loss on these short sales. Who wins and who gets the SHAFT?
The short version – In a short sale, the Buyer submits a bid to the Seller. If the Seller accepts the bid, then the bid will be sent to the property’s mortgage holder for review. The Bank can accept or reject the offer and this step can take anywhere from 30 to 90 days. The Seller also needs to show he/she is in financial hardship to convince the Bank to accept the loss. The Bank will then check the market analysis to make sure that taking the short sale is better than foreclosing on the property.
Who are the winners in a Short Sale?
The RE agents – They make their commission no matter what.
The Buyer’s lender – The Buyer’s lender is more careful these days and probably will not lose their investment. They will make plenty of money from loan origination fee, points, interest, and other closing cost.
The local economy – The local economy benefit from the transaction of property. The appraiser, title company, mover, and many more people will be making some money from the short sale.
The Buyer – Hopefully the Buyer gets the property at a discount. The waiting period is long, but if this is an investment property then the Buyer can use that time to keep shopping. The Buyer can withdraw the offer at anytime during this waiting period.
The Seller’s lender – The Seller’s bank gets some money back from the mortgage loan. They will not get the whole amount back, but they can write off the loss.
The Seller is the one that is getting the Shaft in this short sale. From what I understand, the Seller’s bank will send him/her a 1099 for the amount of loss they took on the loan. The seller’s credit history is going to take a huge hit from the short sale as well.
Example: Robert purchased a home in 2006 for $200k with 5% down, $10k. The original mortgage loan was for $190k. In 2010, the home lost value and was sold short for only $120k. The Bank got $120k back and wrote off $70k. The bank will then send a (surprise?) 1099 tax form for $70k to Robert. This $70k is a Cancellation Of Debt income and is considered as “ordinary income.” Next April, Robert will owe the IRS a huge amount of TAX.
Wow! I didn’t know these details about short sale until now. This sounds like a raw deal for the Seller. Does anyone have any experience as a Seller? Share some stories if you have them.
disclosure: I am not a tax professional, in fact I haven’t even done my tax yet this year. If you are considering a short sale, hire a CPA and make sure you understand the tax implication. A credit score estimator would come in handy for the seller. You may qualify for Federal Mortgage Forgiveness Debt Relief and not have to pay the IRS.