Many homeowners today face a difficult challenge of being upside down in their homes.  Sellers need to know that all is not lost when that happens.  It takes a skilled agent or investor to help them out and they should seek help from a knowledgeable agent before falling in to despair thinking that there is nothing one can do.

Banks today are gearing up for more foreclosures and short sales.  Short sales occur when the lender comes up short on the loan they gave a home owner.  For example, let’s say a seller has a home he purchased for $350,000 with zero down.   His first mortgage is $250,000 and his second is $100,000.   If he has to sell it today, it might only be worth $315,000.  He will have about $22,000 or 7% in selling expenses.  He will net $290,000 which means he’s short $60,000 on his second mortgage.  A short sale of $60,000 must then be negotiated with the note holder for the second mortgage.

Should the bank agree to the short sale, they may lay claim to a deficiency judgement against the seller.  That would mean the seller would still be held responsible to pay that debt off in the future, but they could get out from under the home now.  However, many banks today are foregiving this indebtedness.  By wiping away $60,000 in debt, the IRS considers this taxable income at your earned rate.  The seller is then hit with a 1099 and asked for $10,000 – $20,000 in income tax depending upon his particular situation.  (Note: Congress is working on a bill right now that would eliminate the IRS from coming after sellers who have their debt foregiven in a short sale.  As of the writing of this column, the bill is still working its way through the Senate).

The IRS has a very helpful web site to help figure out these issues.  See “Questions and Answers on Home Foreclosure and Debt Cancellation.”   For additional information, here’s an excellent article on short sales and tax ramifications from Realtor Magazine.