≡ Menu

Who Gets The Shaft In A Short Sale?


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.

Get update via email:
Sign up to receive new articles via email
We hate spam just as much as you
{ 43 comments… add one }
  • Moneycone March 9, 2011, 6:10 am

    That is very, very interesting! I never thought about the tax part for the seller! A short sale is a bad deal for the bank and the seller. The seller won’t get a new loan anytime soon since his credit score would be toast, plus he’ll owe the IRS. Not a good place to be!

    Very informative post RB40!

    • retirebyforty March 9, 2011, 10:18 am

      I never knew that either. That 1099 tax form is going to hurt.

  • Kevin @ Thousandaire.com March 9, 2011, 6:46 am

    That is very interesting stuff. Yet another reason why I don’t know if I’ll ever buy a house.

    • retirebyforty March 9, 2011, 10:19 am

      Don’t let this deter from buying a house. I think it is still a good investment. Or better yet, get a duplex so you can rent out one unit!

  • Aloysa March 9, 2011, 9:48 am

    Why would the seller take a hit on a credit report? Is it because of financial hardship and selling at a loss? Sounds awful!

    • retirebyforty March 9, 2011, 10:21 am

      I think the credit report is hit almost as hard as if you take the foreclosure route. The seller is saying he can not pay the mortgage and the bank have to take a loss. The key here is the bank took a loss so I think this is why there is a big black mark on the credit report.

  • The Financialite March 9, 2011, 10:23 am

    The seller loses out big time! They will get a 1099C from the bank that is a cancellation of debt. So not only do they have to part with their house for much less than its worth, but now they have to pay taxes on the difference as if it was income. OUCH!

  • Squirrelers March 9, 2011, 10:51 am

    Interesting post – you highlight to me that it’s even worse for the seller than I had thought! It’s a tough deal for them. Yet another lesson of why people really need to think hard about the home they buy. Home ownership can be a great thing, but homes aren’t liquid investments like they seemed to be 5 years ago – so be prepared to deal with any debt head on.

    Like the Shaft theme, by the way. Have you seen the recent version, from 7 or 8 years ago? Entertaining.

    • retirebyforty March 9, 2011, 1:37 pm

      Yeah, it’s tough. I think now is the time to buy though. The RE agent told me most properties for sale are short sale, follow by foreclosure, then regular property owners.
      That Shaft theme is a really good song. I saw the SLJ version, fun but not memorable. 🙂

  • krantcents March 9, 2011, 12:25 pm

    I was never a short seller! This is a heavy consequence to an inflated market. RB40 be real careful when purchasing the fourplex. I do not know if this is still true, small properties (duplex & fourplex) pricing is not tied to the properties income. If that is still true, make sure you do not pay too much for the property. Larger properties use a multiple of current earnings (monthly rents) to establish the price. If the rent roll is older (stable renters), your upside (potential) is raising rents or turning over tenants. In essence, this is a business.

    • retirebyforty March 9, 2011, 1:41 pm

      I have never short sell either. Seems like a tough way to go. The smaller properties do not emphasize cap rate much. I’ve only seen one place that showed projected cap rate. I’ll PM you some numbers.

  • Melyssa March 9, 2011, 12:37 pm

    One way to avoid having to pay the taxes is if the seller had already filed for bankruptcy. I think bankruptcy is WAY too easy. I see people hiding their vehicles (parking them elsewhere) so they won’t get repossessed.
    Surprisingly, MANY sellers are doing short sales. And there definitely is nothing short about the length of time it takes to get a buyer.

    • retirebyforty March 9, 2011, 1:40 pm

      Hmm…. If the seller already filed for bankruptcy, shouldn’t they just go the foreclosure route? I think many home owners get relief from Federal Mortgage Forgiveness Debt Relief program. I’m pretty sure investment properties do not qualify for this though.

      • Sandy @ yesiamcheap March 9, 2011, 2:09 pm

        They sure don’t qualify. Investment property is a land of its own.

      • KraziKatt March 3, 2012, 3:56 pm

        I filed bankruptcy to save what I could and kept my home and car. I reaffirmed my car loan, which means I agreed to “own” the debt. I did not do that with the house. I just found out that the house is no longer my debt as it was part of the bankruptcy. I am considering a Short Sale now. I am concerned about the 1099, but I technically no longer have the debt and it no longer shows on my credit report. I am just paying the mortgage monthly. It appears as if I am renting it…I get no equity or credit reporting what so ever even though I have not been late since my bankruptcy over two years ago. (I know a lot of people are hateful toward those of us that are forced into this situation so before I am verbally bashed..I filled due to unforeseen medical issues)

        I was told by the back I can simply walk away from the house…so does that mean since they have already written off the debt that i get the revenue from the house sale?

        • retirebyforty March 3, 2012, 10:48 pm

          You may want consult an accountant or a tax professional. I don’t know enough about bankruptcy to respond.
          Good luck!

  • Lindy Mint March 9, 2011, 1:58 pm

    I hadn’t heard of the 1099, that sounds wicked.

    I’ve also heard mixed reports about a short sale affecting your credit. Some say you can buy a house after three years, depending on the lender (?). I guess I’m not short selling, so I don’t really need to know anyways, but I’m still curious.

    • Lindy Mint March 9, 2011, 2:06 pm

      By the way, my grandfather purchased a duplex, lived in half and rented out the other. It was a great little source of income for him throughout his retirement.

      • retirebyforty March 9, 2011, 9:43 pm

        I wish I knew more when I was younger. I would have thought more about a duplex.
        I think the short sale affect your credit for 2-3 years and a foreclosure is longer at 5-6 years. I’m not sure though.

  • Sandy @ yesiamcheap March 9, 2011, 2:07 pm

    The seller ALWAYS gets the shaft but the seller’s bank does not necessarily get the shaft. Here’s why. Depending on how far along the seller is in the mortgage repayment, the seller’s bank may have already received a ton of interest, especially if it’s a 30 year loan. So the short sale amount may be less than what the seller owes, but the bank may have already received a ton of interest that would have more than made up for the difference. Make sense?

    • retirebyforty March 9, 2011, 9:45 pm

      The seller’s bank probably made some money from the interest already, but if they have loss on the principle, it’s still loss right? The money they made previous years doesn’t matter at this point, but I see what you’re saying.

  • Barb Friedberg March 9, 2011, 3:19 pm

    The “cancellation of debt” notice is aweful. But, wrt to the short sale, there is always a risk when buying an asset!! It goes with the territory. I feel badly for the buyers at the peak of the market.

  • Darwin's Money March 9, 2011, 6:33 pm

    That tax thing is crazy. So, not only are they screwed on negative equity, but then get slammed with a tax bill? We had considered buying a short sale (when we were looking, which we aren’t any more…) but the realtor highlighted you basically have to be a renter because you can never line up the sale with your own sale. The banks ignore you for like weeks, then one day they say “OK” or no. Seems convoluted, but apparently, it’s really tough to time.

    • retirebyforty March 9, 2011, 9:47 pm

      It’s easier with investment property though. We can keep shopping and if we find a better deal, we’ll just withdraw the previous offer. An investor doesn’t fall in love with a home either so they aren’t as emotionally invested.

  • Spruce Up Your Finances March 9, 2011, 9:42 pm

    Very interesting post. Real estate agents always come out winning first during a short sale. On some of the short sales, they were the ones who are actually purchasing the houses since it is a very good deal – discounted home prices.

    • retirebyforty March 9, 2011, 9:50 pm

      I don’t think there are too many RE agents that are buying the short sales anymore. Credit is very tight and I think a lot of them didn’t make much money over the last couple of years.

  • Jessica07 March 9, 2011, 9:47 pm

    I’ve never been the seller, but we almost bought a house as a short sale once. Unfortunately, once we did the math on how much it would take the repair the house (the seller had tried to renovate it before the short sale, hoping to be able to make more–I don’t know WHO advised them to do that!), it would have cost us less to simply buy one not on the short sale. So, that seller took a double hit. 🙁

  • 101 Centavos March 10, 2011, 2:43 am

    Does the seller’s “bank” necessarily benefit? I understand that most mortgages are sold off anyway in the secondary market. And the this debt, this mortgage, is an asset on some entity’s books. Its discharge could be viewed as an asset destruction, and in a fractional reserve system such as ours, a reduction in the money supply.

    Love the Shaft theme, by the way. Right on, baby!

    • retirebyforty March 10, 2011, 10:56 am

      Well, I meant the seller’s mortgage holder. I don’t really know how the asset back security really work once it is sold off. Does the seller’s bank still work with the seller on this or pass him off to the one who own the ABS? That Shaft theme is really cool.

      • 101 Centavos March 12, 2011, 3:07 pm

        I guess that would depend on who is servicing the loan. Our refi was originated by USAA, bought by Freddie Mac, and is being serviced by US Bank. I don’t pretend to understand it all, what with reading about millions of non-performing loans still being held as credible assets on some one entity or another’s books.

  • Kellen March 10, 2011, 7:37 am

    I am interested in buying a house where the seller seems to be committing fraud with his short sale. The listing makes it sound like the house was already bought in a short sale by an investor, who is now re-selling. However, after more research, my realtor is suspicious that the investment company has not bought it yet, and is fishing to see how much they could re-sell for. (i.e. I offer $140k, investment co and seller agree to short sale for $110k, and then split the 30k profit – since it would be a short sale for the investor at either price, his credit will be destroyed in both cases, but with this deal, he’ll get some cash out of it.)

    • retirebyforty March 10, 2011, 11:00 am

      Wow, that is quite fishy. Did they already started the paper work with the bank? Maybe it’s just taking a long time to go through. The investor has no incentive to split the 30k profit with the seller. They could keep the whole thing.

  • Nicole March 10, 2011, 1:35 pm

    The seller gets the shaft compared to what? Compared to foreclosure or compared to not being allowed to short sell?

    • retirebyforty March 10, 2011, 2:42 pm

      I’m thinking – comparing to if they purchased a house they could afford and still make payment. Our primary residence is not under water yet, but it’s close. We’re not moving though, the Mrs. love this place.

      If the short seller owe the IRS that much money, wouldn’t it be better off to just go the foreclosure route?

      • Nicole March 11, 2011, 10:02 am

        The seller kind of made that decision to buy a house they couldn’t afford in the first place. They took a gamble and lost. There’s a reason we bought less house than we could afford, even if one of us lost a job.

        Under that same reasoning, the bank is also getting shafted because they’re not getting the full amount they would have gotten had someone who could actually afford the house bought it. They’re just doing better than they would getting nothing.

        Under foreclosures the seller may still be liable for money, depending on various things. http://taxes.about.com/od/capitalgains/qt/foreclosures.htm

  • Afford-Anything.com March 10, 2011, 2:50 pm

    I bought a triplex in a short sale. It was a fantastic deal-of-a-lifetime for me. I bought it for $100,000 less than the seller owed the bank. I know the neighborhood very well, and there’s no way on earth you could find a comparable house for the price at which I bought it.

    From the buyer’s vantage, there’s a lot of work that goes into buying a short sale. We were worried the seller’s mortgage holder wouldn’t approve, so — working with a civil engineer — I crafted a 25-page report on why the house was structurally deficient and therefore should be sold for substantially less than the surrounding homes. (BTW, fixing the home’s deficiencies will cost much less than the $100K discount I got).

    Putting the report together took about 20 hours … a tiny blip in the grand scheme of life.

    Now I have an amazing triplex; I can live in one unit and rent out the other two!

  • Buck Inspire March 12, 2011, 10:02 pm

    I had a basic idea of what a short sale is. Thanks for adding more details. Wow, the seller really gets shafted with messed up credit ratings and the tax hit. But seriously, the seller put himself into the situation. Shafted to me means the shaftee was taken by surprise or sideswiped with no clue. In my opinion, many people, forced to short sell knew exactly what was going on and just took on too much risk without a proper plan and contingencies.

  • Little House April 10, 2011, 10:44 am

    Thanks for sending me this link! However, there’s a moratorium until 2012 allowing the seller to disregard his 1099-c. So as long as the sale happens before Dec. 31st, 2012, they don’t have to report the cancellation of debt on their taxes.

  • Short Sale Girl April 21, 2011, 9:29 pm

    In Arizona, its very uncommon for a lender to go after the seller for the deficiency… Many of the contracts are now written to prohibit that very thing.

  • Stefan June 22, 2012, 4:43 am

    It seems you do not know what you are talking about. The seller is the winner as he does not have to account for the loss of value of his investment, he only has to pay for the tax.

    This is a fantastic give away that does not exist in any other country or for any other asset.

    Sure some sellers are in hardship and have a hard time to see this as a win but in any other country they would have been stuck with the debt.

    At least here in Florida there are many that lived a good life on raising property values and now they do not have to pay for it…

Leave a Comment