Foreclosure v. short sale

[iplawyer]

All - what are the differences in tax consequences? My daughter's boyfriend is way under water and lost his job. He needs advice. Thanks.

[Judge Roy Bean]

Some questions:
What state?
Who is servicing the loan?
How old is the loan?
Are there any second mortgages involved?
Any prior bankruptcy?

Depending on where he lives, the age (seasoning) and the housing market, the servicer may prefer a foreclosure to a short-sale. Trust me, the fees they add on a foreclosure can be significant and some of them will try to recover a deficiency that includes them.

The primary issue being wrestled with in many of these cases is the servicer's decision on issuance of a 1099. With securitized loans, there is no penalty if they don't. The fact is, in some circumstances they can't square what they say is owed on the loan with what they actually are going to report on their own reports and tax filings and the IRS has given them a pass in those cases. (I think the law that protects borrower/taxpayers in these circumstances is still in effect, but I'm sure the tax experts here will know with more certainty.)

[iplawyer]

Texas
I don't know who is servicing but will find out.
Loan is under two years old.
No second mortgage.
No prior bankruptcy.

[Prof]

In Texas, deficiencies on homesteads are difficult to assert. You need to review the Property Code, but I suspect that the deficiency will vanish. That leaves the forgiveness of indebtedness income issue, which turns on solvency and will, at the very least, remove any positive tax attributes. Since this is a sale of a homestead, does anyone know if forgiveness is affected by the tax free homestead gain provisions?

Short sales are more and more acceptable if there are no subordinate liens.

[iplawyer]

How will the forgiveness affect IRS liability?

[Nikki]

Forgiveness of a debt, unless (among other exceptions) the taxpayer is technically insolvent at the time of forgiveness, constitutes income imputed to the taxpayer.

If a lender forgives, say $100,000, it will issue a 1099 reflecting that amount to both the debtor and the IRS.

The debtor must report that income on the next year's tax return or submit documentation as to insolvency.

Note: These mortgage write-offs are usually big enough dollar amounts to generate one of a number of stiff penalties unless properly reported and handled.

[Investor]

http://www.irs.gov/individuals/article/ ... 14,00.html

He should be fine, as long as he lived in the home as his primary residence for the past 2 years.

EDIT: iPlawyer, I have a bit of experience in helping people with these deals. Feel free to send me a private message if you want my off the cuff take on the process.

DOUBLE EDIT: to answer the original question of this thread, there is no difference (at least not in terms of federal income tax). The tax obligation does not arise from the method by which the home is lost, but rather from the forgiveness of debt, which will likely be the same in either instance...assuming a deficiency judgment doesn't follow the foreclosure; I wouldn't agree to a short sale unless the lender agreed in writing that the deficiency is waived.

[iplawyer]

I thought that there was some recent legislation that made the forgiveness of debt in a forclosure not taxable?

[Investor]

I thought that there was some recent legislation that made the forgiveness of debt in a forclosure not taxable?

It isn't just foreclosures, it is any "Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief." (from the link I provided above). Short Sales are merely restructuring of mortgage loans and fall within the scope of this legislation.

[iplawyer]

Thanks.