Short Sale - Deficiency Judgements vs. 1099

5 Replies

When doing a short sale, what would be better for the distressed seller to do (better for THEIR financial future, not the investors) -- get a 1099 from the lender now, or deal with the deficiency later?
It always depends on their situation, but here might be a common example:
John buys new home from builder in 2004 for $180k, 100% financing. Loses his job today, gets several months behind on payments. Tries to sell the house, but market value on this house is now $150k. Joe Investor comes in and offers to take care of his problem, and negotiates with the lender to buy for $130k.
Now, I have heard from various gurus say that the lender will waive the 1099 or the deficiency judgement, but not both -- is that correct? If so, wouldn't it be better for John to just owe the IRS for the income tax on that $50k vs. have the lender waiting in the wings to attach a judgement, just when John is trying to get back on his feet?

Not all states allow deficiency judgements. Technically if a portion of the loan is forgiven you are required to report the income even if you don’t receive a 1099. Of course, if you don’t get a 1099 the IRS would never know unless someone blew the whistle and they did a full blown audit and investigation.

8)

So, in those states, the bank would always do a 1099? I just can't imagine that the lender would just let that kind of loss go, but I understand well that they are now bogged down w/ many non-performing assets that they need to get off the books.

Originally posted by "corsn1":
So, in those states, the bank would always do a 1099? I just can't imagine that the lender would just let that kind of loss go, but I understand well that they are now bogged down w/ many non-performing assets that they need to get off the books.

You are somewhat missing the point.

In a trustee sale (not a judicial action involving a note secured with a mortgage) the lender has no legal right to a deficiency judgment if there was no fraud when the loan was taken out. The trust deed system works by the lender agreeing to not take the borrower to court when the loan was put in place. In exchange the borrower signs the documents that lets the lender take the house quicker and with less legal hassle (the trust deed). There is a large legal difference between a mortgage and a trust deed even if it seems like the terms are interchangeable.

In all cases the borrower owes taxes on the money forgiven. The IRS can then waive the taxes due. Check the IRS site for more info. They have a specific page with details.

John Corey