When a lender forecloses, or allows a short sale, there is, of course a loss to the lender involved. When this happens, there are really, only 2 options. Either the lender will write off the debt, and therefore issue a 1099-C (Cancellation of Debt) OR They will pursue a Deficiency Judgment.
The best case for everyone, typically, is if they issue a 1099. They get the write-off, and the homeowner doesn't' have to worry about a judgment against them. is the homeowner then liable for taxes on that 1099, you might ask? Well, there are multiple ways to answer that, and I am NOT an accountant. (nor a lawyer, this is not accounting advice or legal advice, there, got that out of the way :P) The first is IRS form 982, which can be found HERE This basically is used when the homeowners debts or liabilities are MORE than their income or assets, in what is called insolvency. When this form is used, there is typically very little to no taxes owed. The other solution is a change in the tax code that former President Bush signed into law in December 2007 (retroactive to January 2007) called the Mortgage Forgiveness Debt Relief Act of 2007 a.k.a HR 3648 (for a brief overview and not the actual law, click HERE. I won't get into all the details, but it works similar to form 982. If the home was your primary residence, or a qualifying second home there will be no tax ramifications to the 1099.
Now on to Deficiency Judgments. This is BAD. A lender, if they have a judgment, can garnish wages, bank accounts, and generally make life miserable for the homeowner, or former homeowner as it were. Now, a lot of times, the people in a short sale situation, are unemployed, or have literally nothing to take, other times, they ARE still employed, and the lender knows the employer. They can garnish wages for this judgment. (I do it to deadbeat tenants as well, it actually quite simple!) The thing with deficiency judgments is that if the lender is going to pursue one after a short sale, there's probably a 99.99999% chance (nope, not a statistician either. :P) that they will pursue one after a foreclosure too. So the decision needs to be made by the homeowner to either continue on with the short sale, and accept that either there is a possibility that the lender will pursue the deficiency, or let the home go to foreclosure instead. A lot of times, we are able to negotiate a full settlement or payment in full and have it in writing that the lender will not pursue the deficiency. There is just no guarantee going in that this is the case however, just as there is no guarantee that the lender will accept any short sale.
What I tell all sellers that I am working with on short sales, is that regardless of how the lender will treat a deficiency, we will communicate with them and advise them of the facts as we know them. (again, we don't offer legal or accounting advice and suggest that all sellers consult their own attorney and/or accountant) If the lender does not give us in writing that they will not pursue the deficiency, we will present this to the seller and ask them if they wish to continue. We also let them know that if they do not, that's okay, but to keep in mind that if the house goes into foreclosure and the bank ends up with possession, they will likely only be delaying any deficiency judgments.
Honestly, I'm seeing more and more that lenders are writing off these losses. They know that in most cases they can't collect on the judgments, and are making an already rough and terrible situation, worse for the homeowner. We will continue to work with them as well to ensure that our sellers are in the best possible situation and get away from any deficiency judgments.
If you want more information on this topic, please comment and let me know what you'd like to hear about. Also, please comment and let me know what you think of this post, and this blog. Your comments will help make this blog a more useful tool for homeowners, agents, other investors, and anyone that wishes to learn more about Short Sales.
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