A short sale is the sale of property for an amount less than what is owed to the lender whose loan is secured by that property. Because most promissory notes accelerate the balance of the loan upon sale of the collateral and because most purchasers would not be interested in buying an existing loan that exceeds the property value, a short sale requires the lender’s consent.
The difference between the sale price and the loan balance is called the “residual debt.” Given the recent plummet in the values of real property, the residual debt remaining after a short sale can be considerable, particularly for first-time home buyers who bought high, sold low, and did not make a significant down payment.
A common misconception is that a short sale extinguishes a borrower’s obligation to the lender–that both parties simply shake hands and walk away with no strings attached. This conclusion is understandable, as the bank may file a 1099-C form in connection with the sale, informing both the IRS and the homeowner that the lender has written off the debt; and given that if the lender had foreclosed the loan, it could not obtain a deficiency against the homeowner for the residual debt.
However, until recently, a 1099-C did not extinguish the debt or waive the lender’s right to pursue it following a short sale. Rather, the 1099-C was merely an accounting procedure and its receipt by the homeowner did not necessarily mean that the lender relinquished the residual debt. Rather, the lender had the option to amend the 1099-C and pursue the borrower on the residual debt.
Passed during the 2011 session, House Bill 2916 A provides greater protections to homeowner- sellers in short sales. It states that a Lender who, in conjunction with a short sale, reports to the IRS that a debt has been cancelled and provides notice of such report to the borrower is precluded from bringing an action to recover the residual debt. However, if the lender does not issue a 1099-C, then the lender reserves the right to pursue the residual debt following the short sale.
Russell Getchell
With a background in teaching middle school students, Russell knows how to craft creative solutions for parties with conflicting viewpoints. Russell practices in the areas of domestic relations, litigation, banking and lending, real estate and land use, and general business.