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Short Sale vs. Bankruptcy

A short sale is an agreement with a mortgage lender to accept the proceeds from a house sale as final payment, despite the fact that the proceeds will fall short of the house's mortgage balance.  Through short sales, owners lose their homes but have no debt.  Similarly, bankruptcy trustees can sell homes and use the proceeds to pay debts.  In both situations, debtors lose their homes but handle their debts.

So, which financial remedy benefits you more?  When deciding whether to file bankruptcy or engage in a short sale, consider the following factors:

  • Other debts beside mortgage default. When you have a lot of unsecured debts—medical bills, credit card debt, or personal loans—bankruptcy may be a better option than a short sale, because you can discharge these debts along with handling the house debt.
  • Tax debt. When you do a short sale, the term for the difference between the amount the house sells for and the house’s mortgage value is a deficiency.  From a tax viewpoint, the IRS considers the deficiency as income, which potentially makes it taxable.  If your house mortgage was for $250,000 and the short sale obtains $200,000, you might have a tax liability of $50,000.
  • Under the Mortgage Forgiveness Debt Relief Act of 2007, if the short sale is for your primary residence and is between the years 2007 and 2012, you have no tax liability for the home sale.  However, if the house is not your primary residence, your tax liability is the same as in the example above.

Your financial circumstances determine whether a short sale or bankruptcy is your best financial remedy to handle debt.  There are also other factors to consider and you should review all the details of your insolvency with an experienced bankruptcy lawyer to make sure you arrive at the best decision.

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