A Ashort sale can happen when a Lender agrees to take less than the total amount owed. In this way, real estate can be sold and the Lender gets a cash pay off.

Lenders are in business to make money and keep down losses. When a Borrower gets behind on their loan payments, the Lender has the right to take the property to pay off the debt. However, in the current real estate market, many properties cannot be sold for the amount owed against them. It is possible to persuade Lenders to take less than the full amount owed if the Lender believes that it will make more money though a short sale than through a foreclosure.

Well, the Lender is relatively happy, because they have resolved the bad loan and kept down their loss. The Buyer is happy, because he bought the property for less than someone else paid for it. The Realtor is happy, because he earned a commission. The Seller is happy, because he has saved his credit and kept a foreclosure off of his record.

So all is well, for a while, but as this nightmare progresses, it might lead you to consider suicide! If you are the Seller, do you realize the lender only released the title to the property? Do you understand that you still owe the Lender the balance on the original loan? Do you know that even though the property has been sold, the Lender can still sue you for the balance you owe? Whether you realize it or not, owing this money damages your credit score. When you receive a notice from the Lender saying that they are Aforgiving the debt, you think that’s great! By forgiving the debt, the Lender has not engaged in an act of compassion or charity. Instead, the Lender has taken a tax deduction and given you a horrible tax consequence.

If you don’t appreciate the nightmare of this tax consequence right away, your bad luck will only get worse. When you fail to include this debt on your next tax return, the IRS computer will automatically select you for a tax audit. The interest and penalties on the amount you owe as a result of an audit can easily double your tax debt. Do you find this hard to believe this nightmare is happening to you? Everyone does! You may want to blame someone, but blaming will not pay the IRS debt, which will be enormous. It is impossible to believe that the IRS considers the money you lost on the sale of the property as if it was money that you EARNED! This is really kicking you when you are

Unfortunately, they are very bad. Here is how you can do the math to estimate the amount you might owe the IRS. Take the total amount you actually earned during the year you lost the property. Add that amount to the amount you lost in the short sale. If the total is below $31,850, the tax will be 15% of the amount you lost. If the amount you lost brings the total to more than $31,800, then the tax on the amount you lost will be 15% of portion that is under $31,800 and 25% of any amount over $31,800. If the total is more than $77,100, you will owe the IRS 28% of the portion above $77,100. The percentages go higher as the total amount increases.

So, if you had earnings of $30,000 in 2007, and sold your property for $50,000 less than the amount you owed, the breakdown would look like this.

Further information on this issue is available on the IRS web site at
http://www.irs.gov/newsroom/article/0,,id=174034,00.html

Yes, as stated on the IRS site, you prevent this problem if you file Bankruptcy. But you must file before the Lender forgives the debt. If you wait to file until after the Lender has issued the certificate forgiving your debt, you may be too late. Although the IRS suggests that Congress may act to help homeowners by changing the tax law, this change was suggested back in April, 2007 and nothing has happened so far. It looks more like wishful thinking than reality.

Very few people are in the position to pay a large tax debt that unexpectedly comes up. After all, you just had to give away your property because you couldn’t make the payments. You probably don’t have a lot of extra cash or access to low-interest credit. Once you owe income taxes, the interest and penalties will quickly increase the amount you owe. In most instances, you will not be able to eliminate this tax debt through Bankruptcy for several years. Other options, such as an Offer in Compromise’ may be available to reduce the tax you owe. No other option is as inexpensive or as certain as filing Bankruptcy before the tax liability occurs. Owing large amounts of income taxes completely devastate your credit and it will be years before you are able to do anything to rebuild it.

If you lost the property through foreclosure, you would not have to pay taxes on the money you lost on the first mortgage. But if you had a second mortgage, you would have to pay taxes on the amount that was lost on any second or third mortgage. However, Bankruptcy would still be an option to prevent you from having to pay this tax liability if you file before the Lender sends you the certificate forgiving your debt.