A short sale or deed in lieu might help prevent foreclosure or a shortage.

Many homeowners facing foreclosure identify that they simply can't afford to stay in their home. If you prepare to quit your home but wish to avoid foreclosure (including the unfavorable acne it will trigger on your credit report), think about a brief sale or a deed in lieu of foreclosure. These options permit you to offer or leave your home without sustaining liability for a "shortage."

To discover about shortages, how short sales and deeds in lieu can assist, and the advantages and downsides of each, check out on. (To find out more about foreclosure, consisting of other options to prevent it, see Nolo's Foreclosure area.)

Short Sale

In lots of states, lenders can sue property owners even after your home is foreclosed on or offered, to recuperate for any remaining shortage. A deficiency takes place when the quantity you owe on the mortgage is more than the profits from the sale (or auction) the difference between these two amounts is the quantity of the deficiency.

In a "short sale" you get approval from the loan provider to sell your home for a quantity that will not cover your loan (the price falls "brief" of the amount you owe the lender). A brief sale is useful if you reside in a state that permits loan providers to demand a shortage however just if you get your lending institution to concur (in composing) to let you off the hook.

If you live in a state that doesn't permit a loan provider to sue you for a shortage, you don't require to arrange for a brief sale. If the sale proceeds fall short of your loan, the loan provider can't do anything about it.

How will a short sale help? The main benefit of a short sale is that you extricate your mortgage without liability for the shortage. You likewise prevent having a foreclosure or a bankruptcy on your credit record. The basic thinking is that your credit won't suffer as much as it would were you to let the foreclosure proceed or file for personal bankruptcy.

What are the disadvantages? You've got to have an authentic offer from a purchaser before you can discover out whether or not the loan provider will support it. In a market where sales are tough to come by, this can be aggravating due to the fact that you will not know ahead of time what the lender is ready to choose.

What if you have more than one loan? If you have a second or 3rd mortgage (or home equity loan or credit line), those lending institutions should also consent to the short sale. Unfortunately, this is often impossible considering that those lending institutions won't stand to gain anything from the short sale.

Beware of tax consequences. A brief sale may create an undesirable surprise: Taxable earnings based on the amount the sale earnings are short of what you owe (again, called the "deficiency"). The IRS treats forgiven debt as taxable income, subject to routine income tax. The excellent news is that thanks to the Mortgage Forgiveness Debt Relief Act of 2007, there are some exceptions for the years 2007 to 2012. To get more information about this Act and your tax liability, see Nolo's short article Canceled Mortgage Debt: What Happens at Tax Time?

Deed in Lieu of Foreclosure

With a deed in lieu of foreclosure, you provide your home to the loan provider (the "deed") in exchange for the lender canceling the loan. The lender guarantees not to start foreclosure proceedings, and to terminate any existing foreclosure procedures. Be sure that the loan provider concurs, in writing, to forgive any deficiency (the quantity of the loan that isn't covered by the sale proceeds) that stays after your house is offered.

Before the loan provider will accept a deed in lieu of foreclosure, it will probably need you to put your home on the market for a period of time (3 months is normal). Banks would rather have you offer your house than need to offer it themselves.

Benefits to a deed in lieu. Many believe that a deed in lieu of foreclosure looks better on your credit report than does a foreclosure or insolvency. In addition, unlike in the brief sale situation, you do not always need to take obligation for selling your house (you might end up merely turning over title and then letting the lender sell your home).

Disadvantages to a deed in lieu. There are a number of downfalls to a deed in lieu. Just like short sales, you most likely can not get a deed in lieu if you have 2nd or 3rd mortgages, home equity loans, or tax liens against your residential or commercial property.

In addition, getting a loan provider to accept a deed in lieu of foreclosure is hard nowadays. Many lending institutions want cash, not real estate particularly if they own hundreds of other foreclosed residential or commercial properties. On the other hand, the bank might believe it better to accept a deed in lieu rather than incur foreclosure expenditures.

Beware of tax consequences. Just like short sales, a deed in lieu may create undesirable gross income based on the quantity of your "forgiven debt." To read more, see Nolo's short article Canceled Mortgage Debt: What Happens at Tax Time?

If your lending institution agrees to a brief sale or to accept a deed in lieu, you may have to pay income tax on any resulting deficiency. When it comes to a brief sale, the deficiency would remain in cash and in the case of a deed in lieu, in equity.

Here is the IRS's theory on why you owe tax on the shortage: When you initially got the loan, you didn't owe taxes on it due to the fact that you were obliged to pay the loan back (it was not a "gift"). However, when you didn't pay the loan back and the financial obligation was forgiven, the amount that was forgiven ended up being "income" on which you owe tax.

The IRS discovers of the shortage when the loan provider sends it an internal revenue service Form 1099C, which reports the forgiven debt as income to you. (To find out more about IRS Form 1099C, checked out Nolo's article Tax Consequences When a Creditor Crosses Out or Settles a Debt.)

No tax liability for some loans secured by your main home. In the past, house owners utilizing brief sales or deeds in lieu were needed to pay tax on the quantity of the forgiven debt. However, the brand-new Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) changes this for specific loans throughout the 2007, 2008, and 2009 tax years just.

The brand-new law provides tax relief if your deficiency originates from the sale of your main residence (the home that you reside in). Here are the guidelines:

Loans for your main home. If the loan was protected by your main house and was used to buy or enhance that house, you might typically omit approximately $2 million in forgiven debt. This means you don't have to pay tax on the shortage.

Loans on other realty. If you default on a mortgage that's secured by residential or commercial property that isn't your primary residence (for instance, a loan on your holiday home), you'll owe tax on any shortage.

Loans protected by but not used to enhance main residence. If you secure a loan, protected by your main house, but utilize it to take a trip or send your child to college, you will owe tax on any deficiency.


The insolvency exception to tax liability. If you don't qualify for an exception under the Mortgage Forgiveness Debt Relief Act, you may still receive tax relief. If you can prove you were lawfully insolvent at the time of the short sale, you won't be accountable for paying tax on the shortage.

Legal insolvency happens when your overall financial obligations are greater than the value of your overall properties (your properties are the equity in your property and personal residential or commercial property). To utilize the insolvency exemption, you'll have to prove to the complete satisfaction of the IRS that your financial obligations exceeded the worth of your possessions. (To get more information about using the insolvency exception, checked out Nolo's article Tax Consequences When a Lender Crosses Out or Settles a Financial Obligation.)

Bankruptcy to prevent tax liability. You can also get rid of this type of tax liability by filing for Chapter 7 or Chapter 13 insolvency, if you submit before escrow closes. Of course, if you are going to file for insolvency anyhow, there isn't much point in doing the brief sale or deed in lieu of, due to the fact that any advantage to your credit score produced by the brief sale will be erased by the bankruptcy. (To read more about using personal bankruptcy when in foreclosure, checked out Nolo's article How Bankruptcy Can Aid With Foreclosure.)

Additional Resources

To find out more about short sales and deeds in lieu, including when these alternatives might be best for you, see Nolo's Bankruptcy and Foreclosure Blog or the bestselling Foreclosure Survival Guide, now readily available online at no charge. Both are written by practicing attorney Stephen R. Elias, president of the National Bankruptcy Law Project.