As most of you know by now, short sales are a lot of work and don’t always come to fruition. That’s why many Realtors and buyers avoid them like the plague.
Well, if Congress doesn’t act before the end of the year, they may become much harder to do, if not impossible.
For those not familiar with this real estate term, a short sale is a type of distressed sale in which the debt on the home exceeds the market value of the property. In these cases, the seller of the home is asking the lender if he is willing to discount the amount of money owed so that the home can be sold and closing expenses (real estate commissions, unpaid property taxes and homeowner association fees) can be paid.
It is highly unlikely that the seller will be willing to lose his entire down payment and stick his hand in his pocket to personally cover the short fall between the offer and the amount of money owed plus closing costs. Most sellers may be resigned to lose the down payment but they aren’t going to throw good money after bad. Hence, the need for the lender to discount the value of the mortgage.
You may ask why would a lender agree to this. Well, he really doesn’t have much choice if the homeowner decides to move or stop paying the mortgage because the home isn’t worth the debt owned on it. These homes are also impossible to refinance because they are no longer worth the debt so no one in today’s tough lending environment is going to give a mortgage of 125 percent of the appraised value of the home. That is not going to happen.
What many people didn’t know about short sales is that the Internal Revenue Service used to consider the debt relief or debt forgiveness in a short sale as taxable income. So, if you owed $500,000 on your home and the bank accepted $400,000, the IRS considered the $100,000 as taxable income. Here you have a homeowner losing his home and down payment only to find the IRS wanting more money. It’s kind of like throwing an anchor to a drowning person.
Because of this debt forgiveness issue, many homeowners found that letting the bank foreclose to be a preferable option. Obviously, the banks didn’t like this because it meant that their losses would increase as the time went on to foreclose on the home.
So, as the real estate mess got worse a few years ago, Congress wisely revised the tax laws so that short sales were no longer taxable events for distressed homeowners.
Buried somewhere in the volumenous bill, was a provision with an expiration date. Guess what? That provision expires at the end of this year unless Congress extends it.
The problem is that this is an election year, so very little is going to get done before the election in November. There are also a bunch of other more important things expiring that will make the lame duck Congress very busy. Things like the interest rate on student loans, debt ceiling and the Bush tax cuts are just a few hot items that need immediate attention but won’t get it until the last moment.
If this provision expires at the end of December, most sellers will not enter into a short sale for fear of getting hit with a big bill from the IRS. As a result, they will just walk away from the home and let the bank eat more of the losses.
I think that because of the full plate in front of Congress now, this won’t get resolved until sometime next year, made retroactive to Dec. 31, 2012. How many people are going to roll the dice on that possibility?
My advice is, if a short sale is something you need or want to do, make sure it closes escrow before the end of the year. Otherwise, as a seller, you are setting yourself up for a potential big tax bite. For buyers, it could very well mean many months of wasting time waiting and having nothing to show for it.
Steven Hyman is the broker and owner of Century 21 Sunset Properties. He can be reached at 726-6346 or century21sunset.com