Short sale after filing BK

[Boscoe]

Ok, here's one that I need guidance on.

Short sale - one of my investment properties has an interested buyer, and my realtor is thinking we may need to do a short sale with them.

Usually, these require a sob story hardship letter and lots of documentation proving that we cannot pay. However, none of that should be necessary since we filed bk and hopefully will be discharged before this takes place.

Does anyone see any issues with allowing a short sale to go through? Even though it will occur after the discharge, I would still be considered insolvent or bk, so no "income from forgiveness of debt".

I would think this would expedite the short sale, as the lender CANNOT collect from me, and this would avoid them having to foreclose and the costs associated with that.

Am I missing anything?

[HHM]

No, you're not missing anything, you have summed it up nicely. But keep in mind, the decision is solely the lenders and generally, they have very strict guidelines from the "true" holders of the note as to when they can and cannot approve a short sale.

Most short sales, to even have a chance of acceptance, should be less than a 25% reduction in the principal balance.

[Boscoe]

I have heard this, but in this market, if lenders are holding out for 25% or less loss, then there won't be alot of short sales.

Either take 35-40% now, or 50-60% or more later...........why would they not consider these and incur further losses upon foreclosure?? I'll never understand it..........

[HHM]

Because the tax write off on profits, and the loss carryover into future years, makes up the difference.

What you have to understand is, even if you are dealing with the Bank that "made" the loan, odds are, they do not own the note. The bank has package the note and securitized it so that it (along with hundreds of other mortgages) is now part of a portfolio that is owned by REIT's and other large investment funds. Thus, your individual mortgage is of little value. Granted, because of the high volume of foreclosures, these "funds" are hurting, but they have no interest in making individual deals with the borrowers. Instead, what they do is sell the portfolio (kinda like credit card companies sell bad debt) to retain some money and take a write off on the loss to off set profits in other areas.

[Boscoe]

Thanks, HHM. When I finally realized this early this year, that is what made me realize that bk was the only real way to go.

But in the situation I am referring to, the bank owns the note, they service all their loans and there is no sell off to any REIT or other investor going on. We'll see. The total outstanding amount is about $295k and the realtor is hopeful that $220k or so will get it done....

We shall see.......

[HHM]

Ok...but realize, unless you sent a qualified RESPA letter requesting the name of the true note owner, you wouldn't know if the bank still holds the note or not.

This scenario is difficult to explain...but, the mortgage note does not change (i.e. the original bank is still shown as the lender, you are the borrower etc), thus, you never receive any notice and your bank still services the payments. What happens is, the note is used to secure a "piece of paper", the security instrument (like a stock certificate or a Bond). And it is that security instrument that is sold to RIET's and other investment funds. As part of the bond, certain rights are transferred. These pieces of paper are known as "asset backed securities". Granted, not every mortgage goes through this process, but most do. The problem for borrowers is, they never know that their note is part of one of these asset backed securities and that the investors have final say on things like short sales, etc.

In any event, I hope it works out for you. I am just trying to give people additional information so they understand what they are up against.

If you get $220, that is just a tad over a 25% reduction, so you have a shot. The sad fact is, despite the housing recession, short sales are still more rare than they ought to be.

[Boscoe]

Well, the loss mitigation company who works with my realtor called the bank and the bank's response was "we need the lawn maintained and the pool cleaned", which suggests that they may be willing to do something.

I have a gain on sale of stock I made in January that I need to offset, so I need one of my properties to be foreclosed on, DIL or short sale by 12/31......

I will keep you posted.

[ssdsco]

I didn't think you could offset stock gains with a loss on a house. I guess you'd be referring to your original down payment.

If you go with the short sale I'd still be concerned about the mortgage company sending a 1099 to the IRS even though it's in your bankruptcy. You may wind up with an IRS issue to deal with.

I had a short sale all lined up on one of my properties. The 1st and 2nd were both with same "large" mortgage company. Balance owed on both loans was $550K. Net on the short sale was $502k. Buyer was well qualified and putting 30% down. Hardship case was approved by the mortgage company department handling the 1st. As soon as the department handling the 1st figured out they were getting paid in full they referred me to the department handling the 2nd. From there it went down a path much as HHM describes. The "investors" saw that only 25% of the 2nd was getting paid and they made it a requirement I sign a promissory note for the shortage in order to approve. I told them to let it go to foreclosure. Now that I'm filing bankruptcy that turned out to be better for me anyway. I avoid the 1099 tax.

Both realtors and I could not understand why they would not accept the short sale without the promissory note. They're not going to get a better deal for years to come.

Through further discussions with the mortgage company it turned out the investors didn't want to show a loss at this time. Apparently by me signing an unsecured promissory note they would not have to show a loss. Also by letting it go to foreclosure that would push out having to show the loss until sometime next year. In the end it was just as HHM describes.

[Boscoe]

What is the difference between the sale proceeds from a short sale vs. the "sales proceed" from the foreclosure? Either way, there is forgiven debt, which is not taxable in a bk.

Unless there are tax accountants out there who say otherwise, my position is that this is not taxable in any way since the debt is being discharged in the bk.

[ssdsco]

I'm not trying to indicate that it is taxable or forgivable either way, just that if you go with the short sale the mortgage company may not connect the dots to the bankruptcy, send the 1099 for forgiven debt to the IRS and then you have explain to the IRS it was discharged in a bankruptcy or they‘ll be looking for the tax on the 1099. Just sounds like a potential hassle and not a real financial issue.

Sorry if I’m not being very clear.

[Boscoe]

From IRS Publication 908 (Bankruptcy Tax Liability)

Debt Cancellation Exclusions:
Do not include a canceled debt in gross income if any of the following situations apply:

The cancellation takes place in a bankruptcy case under the U.S. Bankruptcy Code. See Bankruptcy case exclusion, later.

The cancellation takes place when you are insolvent (see Insolvency exclusion, later), and the amount excluded is not more than the amount by which you are insolvent.


Bankruptcy case exclusion. A bankruptcy case is a case under title 11 of the United States Code, but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

None of the debt canceled in a bankruptcy case is included in your gross income in the year canceled. Instead, certain losses, credits, and basis of property must be reduced by the amount of excluded income (but not below zero). These losses, credits, and basis in property are called tax attributes and are discussed under Reduction of Tax Attributes, later.
___________

They way I read this is that if the cancelled debt is discharged in a bk, there is no tax liability, regardless of whether a short sale, DIL or foreclosure occurs. I will run this one by my CPA to be sure. But I don't see where it would matter. Cancelled debt that is discharged should be excluded, period.

[HHM]

From IRS Publication 908 (Bankruptcy Tax Liability)

Debt Cancellation Exclusions:
Do not include a canceled debt in gross income if any of the following situations apply:

The cancellation takes place in a bankruptcy case under the U.S. Bankruptcy Code. See Bankruptcy case exclusion, later.

The cancellation takes place when you are insolvent (see Insolvency exclusion, later), and the amount excluded is not more than the amount by which you are insolvent.


Bankruptcy case exclusion. A bankruptcy case is a case under title 11 of the United States Code, but only if the debtor is under the jurisdiction of the court and the cancellation of the debt is granted by the court or occurs as a result of a plan approved by the court.

None of the debt canceled in a bankruptcy case is included in your gross income in the year canceled. Instead, certain losses, credits, and basis of property must be reduced by the amount of excluded income (but not below zero). These losses, credits, and basis in property are called tax attributes and are discussed under Reduction of Tax Attributes, later.
___________

They way I read this is that if the cancelled debt is discharged in a bk, there is no tax liability, regardless of whether a short sale, DIL or foreclosure occurs. I will run this one by my CPA to be sure. But I don't see where it would matter. Cancelled debt that is discharged should be excluded, period.

I'd probably agree with your interpretation.

Boscoes issue is not a tax liability issue, it is merely whether the bank will accept the short sale or not. These houses were included in BK, so any deficiency balance on the short sales should not be taxable (but I am not 100% sure).

The capital gain/loss issue may be more tricky. I am not sure you use the "loss" on investment property to offset personal capital gain from sale of stock. Rental properties fall under "Sale or Trade of Business, Depreciation, Rentals: Sales, Trades, Exchanges" and is reported on form 4797, and therefore, I think you can only offset the loss against other "business" gains.

But you can discuss that issue with the CPA and that issue is beyond the scope of this forum.

Please keep us updated and let us know how it goes.

[Boscoe]

HHM - you are right about that for "rental" properties. But this is not a rental property.

Thanks.

[HHM]

HHM - you are right about that for "rental" properties. But this is not a rental property.

Thanks.

Ok, so this is a "flip gone bad". I still think you run into issue with the property being a "non-capitial" asset and therefore the "business gain/loss" rules apply.

In any event, you will want to look at Publications 544 http://www.irs.gov/publications/p544/index.html

[SleepWellNow]

My advice is to tak to a CPA before you do anything just to know where you stand. I wish we had done that! We just completed a short sale on an investment (rental) property and were hit with a California State withholding tax of over $13K. Found out about this the day before closing. Fortunately, we had the money to pay half of it and the lender paid the rest.

We are working on 2 other short sales and the lenders are being very cooperative. The lender on the one we just sold was also cooperative. In my opinion, these lenders are more amenable to a short sale BECAUSE of the BK. We don't owe anything on the property (so our current financial condition doesn't really matter), our "hardship" is already established by the BK, our credit is already trashed, and we can just as easily let the houses go to foreclosure. Plus, the lenders know they will recoop more money by a short sale than a foreclosure.