Friday, November 20, 2015

Tread Carefully when Buying or Selling a Short Sale Home


Short sale properties are sold for less than what’s owed on the mortgage loan. It’s a provision for homeowners who can’t afford their mortgage payment, and it’s a way for these borrowers to avoid foreclosure.

A short sale can also be advantageous for buyers. These properties are sometimes cheaper, so you can buy more house for your money—but don’t get excited too quickly. Whether you’re a buyer or a seller, there are definitely some reasons to stop and consider if you want to go down the path of the short sale.

 Buying a short sale home

Short sales are often fixer-uppers



Short sales are sold as-is, and in many cases, these homes need a lot of work. Because the previous owner had financial hardships, he probably didn’t have resources to keep up with home maintenance and repairs.

From a price point, a short sale can be an excellent deal, but you’ll need money to improve the interior and exterior of the home. This includes updating the kitchen and bathrooms, replacing the flooring, painting the walls and making other structural improvements. It’s the perfect property if you don’t mind some renovations, but if you’re looking for a move-in ready property, a short sale may not be the right property for you.

Not every house qualifies for a short sale


Some home sellers and real estate agents don’t fully understand how short sales work, and they might list the house as a short sale before getting permission from the bank.

Before bidding on a short sale, speak with your real estate agent so he can confirm that the seller’s bank is aware of the situation. There are rules for short selling a property. For example, the seller must prove there’s some sort of financial hardship, and they must have defaulted on their mortgage loan. Additionally, a seller cannot request a short sale if he’s filed bankruptcy. Don’t waste time bidding on a property that doesn’t meet a lender’s short sale qualifications.

Short sales have a lengthy approval time

Even if you’re pre-approved for a mortgage and ready to purchase, you’ll need to be patient. Buying a short sale takes longer than buying other properties. With a non-short sale property, you can realistically close within two to four weeks. Since there’s a lot of back-and-forth and red tape with short sales, it can take as long as 90 days to purchase these homes—that’s if the bank approves the sale. At the end of the day, you need the lender’s approval, and the bank can decide at the last minute not to approve a short sale, putting you back at square one.



Selling a short sale home

Short sales produce potential tax problems



What many people don’t realize is that if your lender allows you to sell your home at a loss, you may be liable for taxes on the losses incurred by the lender.  The IRS considers a short sale loan forgiveness.  Loan forgiveness is considered debt discharge income (DDI), and DDI is taxable.

If a lender forgives more than $600 of principal, they might send you and the IRS a 1099-c form, and you are required to report the loss as income.  In many cases whether you have a tax liability or not will depend upon your lender.  Some lenders will report the DDI to the IRS, others will not.


In addition to DDI, there can be other tax implications with a short sale


Take for example the case of someone who bought a $100,000 home.  The market did well and the property increased in value to $125,000.  At the peak, the borrower taps the home’s equity and took out a second mortgage for $50,000. Now the borrower has a house worth $125,000 and $150,000 worth of mortgages (first and second).

The market stagnates and they sell the house in a short sale for $125,000.  For tax purposes, they have actually made $25,000, despite being $25,000 shy of breaking even on their mortgages.  This is because the sales price exceeds the tax basis of the home.  Mortgage debts do not factor into gain-on-sale calculations.  This is in addition to the taxes that must be paid on $25,000 worth of DDI.  It is possible that the $25,000 gain may be excluded from taxes as a result of the federal home sale gain exclusion tax break.

Now take the example of a person who purchased a home (to be their primary residence) for $100,000, the market improves and the house appreciates to $125,000.  The homeowner borrows $50,000 against their home equity, and now has $150,000 worth of mortgage debt. Then the market declines and the house is worth $75,000 and is sold in a short sale. The borrower is left with $50,000 worth of DDI, but they have also incurred a $25,000 loss on the property.  The borrower may not deduct the loss.  This is because you may only claim losses on investment or business properties, not principal residences.

There are some circumstances where DDI can be exempt from taxes. If the debt write-off is deemed a gift, discharged in bankruptcy, or you were insolvent (have debts that are in excess of your assets) at the time the lender forgave your debt, your DDI may be exempt from taxes.

Consult an accountant, lawyer, and mortgage professional when undertaking a short sale

There are many benefits, but some downsides associated with short sales.  In addition to DDI taxes, increasing numbers of banks are making the borrower sign a promissory note for the lender’s losses or agreements that allow the bank to pursue the borrower for deficiency when selling a home in a short sale.

 Bottom Line

If you’re not in a hurry to purchase a home, a short sale might be the answer. On the other hand, if you’re looking for a quick and simple sale, and if you don’t have the patience for a lot of back-and-forth negotiations with the mortgage lender, you might do better skipping a short sale and buying a traditional listing.

source: totalmortgage.com