Short Sale When You Can't Make Mortgage Payments

Added August 19, 2007 by Ilyce R. Glink

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Summary: When you've bought a home and you owe more that the home value it may become difficult to make mortgage payments. Instead of falling behind on your mortgage payments you may want to contact your mortgage lender to set up a short sale. Be aware that when you sell your home through a short sale the IRS will treat the difference between the sale amount and what you originally owed the lender "phantom income."

Q: I am in a very bad situation. I bought my house 18 months ago for $358,000. Now, similar homes in the area are selling only for $345,000.

I tried to sell the property but I'd have to come up with almost $30,000 to close, and that's money I just don't have. I can't afford the payments anymore, and yet, if I don't sell the property or figure out a way to come up with the payments, I'm going to be forced not to pay them.

I want to try to convince my lender to do a short sale. Can I do that before being late on my payments? Help!

A: You're in an incredibly difficult situation. From where I sit, you only have two options at the moment, neither of them particularly pleasant: You can either get a part-time second job to help increase your income (so that your payments are affordable), or you can sell your home and find a way to get $30,000 in order to pay off the lender.

You can ask the lender to do a short sale. If you don't have any other assets, the lender may agree to it, but that will bring up another unpleasant subject: income taxes.

What you may not realize is that the IRS treats a short sale as income to the borrower. So if you owe $350,000 on your loan, but sell your home for $330,000, you owe $20,000 to the lender. If the lender accepts the lesser amount (known as a short sale), the IRS will see the missing $20,000 as "phantom" income. You'll then owe income taxes on the phantom income.

I know this seems unfair, so I hope you can figure a way out of this problem. Please talk to a good real estate attorney about how short sales work and whether this is truly a good option for you at this time.

Good luck.

Aug. 19, 2007.

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