Following is a great post I came across about with great advice if you're in a short sale situation. A short sale is still preferable to foreclosure-- call me today if you need to sell your home!
It is bad enough that a short sale does involve the loss of a home with no equity to show for it, and a negative credit record that may last for a long time; it also has the potential to make two very bad after-effects. One is that the lender may continue to pursue the seller for the remainder of the debt. The other is that the I.R.S. seek a tax on the amount of the unpaid debt.
The borrower may have been required to sign a promissory note for the difference between the debt and the sale proceeds. Or, a lender may require the borrower to sign a paper acknowledging that the lender reserves its right to pursue the borrower for that amount.
The second possibility lies in the fact that, if a debt is forgiven, the borrower may be taxed on the amount he didn't have to pay back. (see I.R.S. publication 4681). There are some exemptions.
I don't think that a seller that sells short should suffer both.
Here is what can happen: In allowing the short sale, the bank requires the borrower to sign a note for the difference, or to acknowledge that the bank has the right to take action to collect that amount. Also, probably sometime later, the bank sends out a 1099-C, informing the I.R.S. that a certain amount of debt had been cancelled.
NO ONE who has dealt with a short sale would raise the question: "How could this happen? The two actions contradict each other!" That is because anyone who has been through the process knows that it is common for the right hand of the bank not to know what the left hand is doing!
Sellers should retain all paperwork. If they signed a document to the effect that the bank was going to pursue its unpaid interest, he should hang on to that. Then, if he receives a 1099-C saying that the debt was forgiven (and, therefore, taxable), he will have support for the claim that the 1099-C is incorrect.
On the other hand, suppose that there was no specific release of the debt and that the paperwork contained no reference to it. Then, if the seller receives a 1099-C, saying the debt was cancelled, he should keep that, just in case the bank comes a calling!
Michele,
Thank you for your posting, much appreciated.
-David
Great post. Keeping paperwork in all financial transactions is important for tax reasons. Better to keep the paper vs. throwing away and never knowing if $$$ could have been saved.
David and Ann-- thanks so much for stopping by and for your comments! I thought this post should be passed on-- really good info from Anjelica Blatt.