Short Sales Can Leave Homeowners Short

Settling the Debt

In most cases, the remaining unpaid debt is forgiven by the lender and written off as a loss. Normally, that unpaid debt is a tax liability for a homeowner since the amount of forgiven debt is taxable as regular income. In response to the current housing crisis, however, Congress enacted the Mortgage Forgiveness Debt Relief Act of 2007. The Act removes the tax liability from $1 million or less of debt forgiven on a primary residence during 2007, 2008 and 2009. Most homeowners will qualify for the tax break, provided that the lender chooses to write off the debt. Check out the IRS Web site for more information.

In negotiations with the lender, make sure the debt will be forgiven. The lender has the option to sue to recoup the unpaid balance, even after the short sale is concluded. Without the written promise to forgive the debt, a homeowner could still find himself on the hook for the remainder of the loan.

Before agreeing to a short sale, lenders often request proof of real financial hardship in the form of medical bills, lost wages or a divorce. And in most cases, lenders won't agree to a short sale until you're already behind on payments. But by ensuring that any short-sale agreement includes conditions for credit reporting and debt forgiveness, it may be the best solution to a difficult situation.