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Foreclosure and Short Sale Information For legal questions and advice regarding real estate, foreclosures, short sales and bankruptcy consider joining Pre-Paid Legal Services. 1. IRS information on foreclosure and debt cancellation 2. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments 3. IRS Publication 544, Sales and Other Dispositions of Assets, under the section “Foreclosures and Repossessions”. 4. IRS Publication 908, Bankruptcy Tax Guide 5. IRS Form 1099-A, Acquisition or Abandonment of Secured Property 6. IRS Form 1099-C, Cancellation of Debt, used by lenders to report cancellation of your debt 7. IRS Form 9465, Installment Agreement Request, used to request a monthly installment plan to pay taxes due 8. IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness 9. Real Estate Short Sale A short sale occurs when the net proceeds from a real estate sale, after closing costs and commissions, are less than the current mortgage balance due on the property. To qualify for a short sale, the real estate owner must show the lender proof that the property did not or would not sell for an amount equal to or greater than the balance due on the mortgage. They must also submit proof that they are suffering from a financial hardship and do not have enough other income or assets to make up the shortfall. A desire to sell simply because the property has dropped in value is not a financial hardship. The lender must approve the short sale. The mortgage lender may be willing to accept a short sale to keep their loan loss as small as possible. A foreclosure will take more time and expense, and if property values are still dropping, may result in a larger loss. If the lender forecloses, potential buyers usually make low priced offers on foreclosed properties, and there is a risk of theft, vandalism and deterioration at vacant properties. Some real estate agents, consultants and other advisors specialize in handling short sales and foreclosures. Credentials include CDPE (Certified Distressed Property Expert) and SFR (Short Sales and Foreclosure Resource certified). Other than a short sale or foreclosure, the borrower should also investigate a loan refinance, restructuring or workout, a sale where the seller brings cash to closing to pay of their loan, and a deed in lieu of foreclosure. Abandonment of the property is not an acceptable choice. Some lenders require the property to be occupied to reduce security risks such as theft, vandalism and trespassing. Borrowers should be careful of foreclosure rescue scams and not give out confidential personal or financial information to strangers without doing research about their reputation and credentials. It is best to work with trained, licensed professionals and use written agreements that protect confidential information. Contact us for more information. Steps in a Short Sale 1. Determine the current market value of the property and do a Comparative Market Analysis (CMA). Get a Broker Price Opinion (BPO), check recent comparable sales in the area, check websites such as Zillow.com that have pricing information. How many short sales, foreclosures and REOs are there? What is the average listing time? What is the unemployment rate and trend? What is the average house rent for this neighborhood? What is the rental vacancy rate and trend? What is the estimated market value to sell it as a profitable rental property? How many newly built houses are for sale? Determine the absorption rate. Divide the total inventory for sale by the number of houses sold per month. Determine the housing price trend. Is it falling, flat or rising? Falling prices motivate lenders to approve the short sale quickly to avoid a bigger loss. If the price is set too high, the property will not sell. The price should be set at the lower end of the fair market value and then adjusted if needed to match changing market prices. 2. Determine your closing costs: (average 3%) title report, escrow, appraisal, attorney fees, real estate commissions (average 6%), unpaid property taxes. 3. Use a licensed home inspector to discover any problems. Get a contractor's written estimate the cost of any maintenance, painting or repairs needed or desired to attract a buyer quickly. Take photos of the property condition before doing any repairs. The lender may be willing to pay for the cost of repairs, closing costs and commissions to sell the property. To sell to a typical retail homeowner, for the highest price, they want a home in good, attractive condition, not a fixer upper. That's too much work. Buyers do not want to wait several months for a lender to approve a short sale. Some real estate agents may not even consider recommending short sale properties for their clients due to their lack of knowledge or the extra time involved. Investors may be willing to wait longer and buy a fixer upper, if the price is low. Kitchen and bath remodeling and updating usually produces the best return on your money. Nice landscaping is needed for strong curb appeal. Make sure the carpets and property are clean. 4. Calculate your equity. If the loan balance is greater than the market value of the property, minus the estimated closing costs and commissions, then a short sale should be considered. 5. Contact your lender and find out their short sale policy and contact person regarding short sales, often a loss mitigation or loan workout department. They may require you to be 3 months behind in payments, meet their financial hardship requirements, or they may not approve short sales at all. Find out the documents that you are required to submit in your short sale package. If you are not comfortable negotiating with the lender, hire a trained professional short sale specialist. An independent specialist may charge a fee of 25% to 35% of the commission at closing. Avoid paying upfront fees. Some real estate agents have attended training classes and can handle short sales. The lender will ask the borrower to provide their current (within 3 months) financial information. This will reveal to the lender if the borrower has other assets or income to go after in a deficiency judgment. Once you submit a short sale package for approval, make sure the lender does not proceed with a foreclosure. Their loss mitigation department may not communicate with their foreclosure department, especially with large national companies. Lender's may not be willing to pay off any Home Owners' Association (HOA) dues or certain other liens at closing. 6. Consider the tax consequences if there will be cancelled debt reported to the IRS that you must report as income and pay taxes on. There are special tax exemptions for homeowners and if you are insolvent (liabilities exceed assets) at the time of the cancelled debt. See IRS Form 982 and Publication 4681 and seek tax advice. 7. Consider the possibility of a lender seeking a deficiency judgment against you. Some states and certain loans are non-recourse. This means the loan is secured only by the property and the borrower is not personally liable if there is any loan deficiency when the property is sold. Most states and loans are recourse, where the borrower is personally liable for paying back the entire loan. Anti-Deficiency / Non-Recourse
States: (always seek legal advice) Will the lender file a lawsuit against you personally to recover any financial loss on the loan? A deficiency amount in a short sale will be less than in a foreclosure. A lender is more likely to issue a 1099-C Cancellation of Debt notice in a short sale and to seek a deficiency judgment in a foreclosure. A lender may wait a while before seeking a deficiency judgment if they think that will improve their chances of collection. Seek legal and tax advice. 8. Market the property and find a buyer. Get it listed in MLS. Follow MLS rules for disclosing short sale listings. Consider using a flat fee real estate listing agent that uses MLS. Use signs. List on websites. Avoid ineffective newspaper ads. Seek out buyer's brokers that are looking for properties for their clients. Investors that specialize in buying short sale properties, at a fair price, may be the best buyers. Eliminate unattractive items and clutter, clean and stage the property to make it attractive. On average, offers are usually 3% lower than the asking price. Once you have an acceptable offer, submit it to the lender for short sale approval. They may need to get the offer approved by the current loan owner(s). Check the approval status every few days, but do not become a nuisance to the lender and do not argue. Be professional or use a professional. Try to get a direct phone number and talk to the same person each time you call. Take notes. Note that the buyer's offer may prohibit other subsequent offers from being submitted to the lender until they receive a response from the lender. Subsequent offers might be held as backup offers only. The lender may not approve an offer that is assignable, which allows investors to flip the deal for a quick profit. If the offer is too low, they may counteroffer with a price closer to the appraised value or Broker's Price Opinion (BPO). Submit your own BPO, including an inside inspection, at the low end of the fair market value. Lenders vary, but may accept offers ranging from 80% to 90% of the BPO, lower in distressed neighborhoods. Lenders on second mortgages typically accept 10% to 15% on the dollar as settlement. Once a seller has a lender approval letter, they should have it reviewed by their legal and tax advisors before proceeding. Properties For Sale By Owner are often listed on Craigslist.com and Backpage.com. Short sale investors may find short sales listed here because owners may not have enough equity or money to pay real estate commissions. Investors may reply to the ad and provide their phone number and email, stating that they buy houses, in any condition, even if the loan is greater than the property value, and may help stop foreclosure. 9. Investors will likely have documents they need the seller to sign including: an Authorization to Release Loan Information for the mortgage company, a Purchase Contract, giving the investor the option to buy the property, but not the obligation, a Memorandum of Agreement, a recorded document to notify the public of the signed purchase contract, Short Sale Addendum, and Inspection Addendum. The lender's Short Sale Package includes specific documents required by the lender to complete a short sale, including a Proof of Funds Letter and a preliminary HUD-1 settlement statement. The blank Short Sale Package forms may be faxed or mailed by the lender to the borrower or investor. It is good practice to include the borrower's name and loan number on each page, in case any pages get separated during processing. 10. A short sale will likely damage your credit history and lower your credit score by about 50 to 100 points. Ask the lender if they will agree to not report your few late mortgage payments to the credit bureau if you can find a buyer quickly and avoid a foreclosure. Or ask to have it reported as "Settled as Agreed". If possible, try to do a short sale while keeping your payments current. The short sale approval letter may explain how the lender will report the transaction to the credit bureaus. Make sure it does not get reported as a foreclosure. A foreclosure is worse for your credit history, and will lower your credit score by about 200 to 300 points, and remain on your history for 7 years. A bankruptcy remains on your credit history for 10 years. With a short sale on your credit history, you might be able to get a new mortgage loan in 2 or 3 years. With a foreclosure, it will likely take 5 years or more, if you have re-established a good credit history and are paying other credit accounts on time. 11. A Hardship Letter is usually part of the short sale package and is written by the seller or their representative. It is used to explain to the lender the reasons for the borrower's need for a short sale. A simple letter should be sufficient. Date
Borrower's
Signature Date 11. Taxes Due on Cancelled Debt Cancelled debt of more than $600 is reported on Form 1099-C by the lender to the IRS and a copy is sent to the taxpayer. Cancelled debt is normally reported as "Other Income" by the taxpayer, unless certain exceptions apply. The Mortgage Debt Relief Forgiveness Act of 2007, applies to the sale of qualified principal residences after 2006 through 2012. Homeowners may not have to pay taxes on cancelled debt if they qualify. The Act does not apply to second homes, business properties, rental properties, or other types of cancelled debt, like credit cards or car loans. See IRS Publication 4681 and Form 982 for more information. Other exceptions to taxes on cancelled debt apply to non-recourse debt (where you are not personally liable for repaying the debt), debt discharged in bankruptcy, insolvency (liabilities greater than assets), certain student loans, and qualified farm debt. Contact us for more information. Disclaimer: This information is for educational purposes only. None of this information is to be considered or used as legal or tax advice. For legal advice, contact an experienced lawyer. For tax advice, contact an experienced tax lawyer or other tax professional. |
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