A brief sale or deed in lieu may help prevent foreclosure or a deficiency.

Many property owners dealing with foreclosure figure out that they just can't manage to remain in their home. If you prepare to provide up your home however wish to avoid foreclosure (including the it will cause on your credit report), think about a brief sale or a deed in lieu of foreclosure. These choices permit you to offer or ignore your home without incurring liability for a "deficiency."

To discover shortages, how short sales and deeds in lieu can help, and the benefits and drawbacks of each, continue reading. (To get more information about foreclosure, including other options to avoid it, see Nolo's Foreclosure area.)

Short Sale

In numerous states, loan providers can take legal action against property owners even after the house is foreclosed on or offered, to recuperate for any staying shortage. A shortage happens when the quantity you owe on the mortgage is more than the profits from the sale (or auction) the difference in between these two quantities is the quantity of the deficiency.

In a "brief sale" you get consent from the lender to sell your house for an amount that will not cover your loan (the price falls "brief" of the amount you owe the lender). A brief sale is advantageous if you live in a state that allows lenders to demand a shortage but just if you get your loan provider to agree (in writing) to let you off the hook.

If you live in a state that does not permit a lending institution to sue you for a deficiency, you don't need to organize for a brief sale. If the sale continues fall brief of your loan, the loan provider can't do anything about it.

How will a short sale help? The primary advantage of a brief sale is that you extricate your mortgage without liability for the shortage. You likewise prevent having a foreclosure or a personal bankruptcy on your credit record. The general thinking is that your credit won't suffer as much as it would were you to let the foreclosure continue or apply for insolvency.

What are the drawbacks? You've got to have an authentic deal from a buyer before you can discover whether or not the lending institution will go along with it. In a market where sales are difficult to come by, this can be frustrating because you won't know ahead of time what the lender is ready to choose.

What if you have more than one loan? If you have a 2nd or third mortgage (or home equity loan or line of credit), those loan providers need to likewise consent to the short sale. Unfortunately, this is frequently impossible considering that those loan providers won't stand to acquire anything from the brief sale.

Beware of tax repercussions. A short sale might generate an unwanted surprise: Gross income based on the quantity the sale proceeds lack what you owe (again, called the "shortage"). The IRS treats forgiven financial obligation as taxable income, subject to routine earnings tax. The bright side is that thanks to the Mortgage Forgiveness Debt Relief Act of 2007, there are some exceptions for the years 2007 to 2012. For more information about this Act and your tax liability, see Nolo's post Canceled Mortgage Debt: What Happens at Tax Time?

Deed in Lieu of Foreclosure

With a deed in lieu of foreclosure, you offer your home to the lender (the "deed") in exchange for the lender canceling the loan. The lender assures not to start foreclosure proceedings, and to end any existing foreclosure procedures. Make sure that the lending institution agrees, in writing, to forgive any deficiency (the amount of the loan that isn't covered by the sale earnings) that remains after the house is sold.

Before the lender will accept a deed in lieu of foreclosure, it will probably need you to put your home on the market for a time period (3 months is typical). Banks would rather have you offer your home than have to sell it themselves.

Benefits to a deed in lieu. Many think that a deed in lieu of foreclosure looks much better on your credit report than does a foreclosure or bankruptcy. In addition, unlike in the short sale circumstance, you do not necessarily need to take responsibility for selling your home (you might end up merely handing over title and after that letting the lender sell the home).

Disadvantages to a deed in lieu. There are several failures to a deed in lieu. Just like short sales, you most likely can not get a deed in lieu if you have 2nd or 3rd mortgages, home equity loans, or tax liens versus your residential or commercial property.

In addition, getting a loan provider to accept a deed in lieu of foreclosure is hard nowadays. Many lending institutions want cash, not real estate especially if they own hundreds of other foreclosed residential or commercial properties. On the other hand, the bank might think it better to accept a deed in lieu instead of incur foreclosure expenditures.

Beware of tax consequences. As with short sales, a deed in lieu may create unwanted gross income based on the amount of your "forgiven financial obligation." To get more information, see Nolo's article Canceled Mortgage Debt: What Happens at Tax Time?

If your lending institution agrees to a short sale or to accept a deed in lieu, you may have to pay income tax on any resulting deficiency. When it comes to a short sale, the deficiency would remain in money and in the case of a deed in lieu, in equity.

Here is the IRS's theory on why you owe tax on the shortage: When you first got the loan, you didn't owe taxes on it due to the fact that you were bound to pay the loan back (it was not a "present"). However, when you didn't pay the loan back and the debt was forgiven, the quantity that was forgiven ended up being "income" on which you owe tax.

The IRS learns of the shortage when the lending institution sends it an IRS Form 1099C, which reports the forgiven financial obligation as earnings to you. (To get more information about IRS Form 1099C, read Nolo's article Tax Consequences When a Creditor Writes Off or Settles a Financial Obligation.)

No tax liability for some loans secured by your main home. In the past, homeowners utilizing brief sales or deeds in lieu were required to pay tax on the amount of the forgiven debt. However, the new Mortgage Forgiveness Debt Relief Act of 2007 (H.R. 3648) changes this for certain loans throughout the 2007, 2008, and 2009 tax years only.

The new law provides tax relief if your shortage comes from the sale of your primary home (the home that you live in). Here are the rules:

Loans for your primary home. If the loan was protected by your primary home and was used to buy or enhance that house, you might normally leave out up to $2 million in forgiven debt. This implies you do not have to pay tax on the shortage.
Loans on other realty. If you default on a mortgage that's secured by residential or commercial property that isn't your main home (for example, a loan on your villa), you'll owe tax on any deficiency.
Loans secured by but not utilized to enhance primary home. If you secure a loan, secured by your main residence, however utilize it to take a holiday or send your kid to college, you will owe tax on any deficiency.
The insolvency exception to tax liability. If you don't qualify for an exception under the Mortgage Forgiveness Debt Relief Act, you might still receive tax relief. If you can show you were legally insolvent at the time of the short sale, you won't be liable for paying tax on the shortage.

Legal insolvency occurs when your total financial obligations are greater than the value of your total properties (your properties are the equity in your genuine estate and individual residential or commercial property). To utilize the insolvency exclusion, you'll have to prove to the satisfaction of the IRS that your financial obligations exceeded the value of your assets. (For more information about using the insolvency exception, checked out Nolo's article Tax Consequences When a Lender Writes Off or Settles a Financial Obligation.)

Bankruptcy to avoid tax liability. You can also eliminate this type of tax liability by declaring Chapter 7 or Chapter 13 bankruptcy, if you file before escrow closes. Obviously, if you are going to apply for personal bankruptcy anyway, there isn't much point in doing the short sale or deed in lieu of, due to the fact that any benefit to your credit rating produced by the short sale will be wiped out by the bankruptcy. (To find out more about using personal bankruptcy when in foreclosure, checked out Nolo's post How Bankruptcy Can Aid With Foreclosure.)

To read more about short sales and deeds in lieu, consisting of when these choices might be best for you, see Nolo's Bankruptcy and Foreclosure Blog or the bestselling Foreclosure Survival Guide, now readily available online at no charge. Both are composed by practicing attorney Stephen R. Elias, president of the National Bankruptcy Law Project.