It is a common situation anymore. An individual or couple can no longer afford the mortgage payments on their home and they want to sell it. However, the market has dropped since they bought their home and they now owe more than the home is worth. They will not be able to sell the house for enough to clear the mortgage and pay the closing costs. But they have heard that the mortgage company may agree to accept less than the balance of the mortgage to allow the house to be sold. This is what is called a short sale. It seems like a win for everyone involved; the mortgage company doesn't incur the fees and problems with having to foreclose on the property, the homeowners have some control over the timing of the sale and the house doesn't end up sitting vacant.
Up until December 31, 2013, a short sale could be an effective way for a homeowner to get out from under a mortgage they could not afford. However, when a lender, such as a mortgage company, agrees to accept less than the full amount that they are owed in satisfaction of a debt, the difference is called forgiveness of debt and this is taxable income to the borrower. To try to put that in more basic terms, let's say that you owe $200,000 on the mortgage for your home in Norfolk, you have a contract for sale that will pay the mortgage company $175,000 and they agree to accept that amount. The mortgage company has forgiven $25,000 of the mortgage and you will have to claim that $25,000 as taxable income. There was a provision in the tax code that said if the forgiven debt was due to a short sale on your principal residence, you did not have to pay taxes on it. But that provision expired on December 31, 2013.
Now if you do a short sale on your house, you will incur tax liability for the amount of the mortgage that the mortgage lender did not receive. This could cause you to owe a significant amount of taxes for money you did not receive. On the other hand, if you surrender your house in a bankruptcy, you do not incur any tax liability.
If you are upside down in your house and no longer want to keep it, the best option may be to surrender the house in a bankruptcy. You will also be able to deal with other debt that you have at the same time. Contact Hampton Roads Legal Services at 757-320-2010 to schedule an appointment with me to discuss how bankruptcy can help to free you from your mortgage and other debts without incurring tax liability.