A rental property short sale is not nearly as bad as you might think. In fact, they tend to rather simple and harmless. That is, if you know what you’re doing. Most rental property owners are concerned because they don’t qualify for the Mortgage Debt Relief Act, but as long as your taxes are done properly, it doesn’t matter. Also, if you bought the property as a primary residence, then turned it into a rental, you still qualify for the Mortgage Debt Relief Act whether you need it or not.
When you short sale a property, the Bank agrees to take a loss equal to the amount you are “short”. For example, you sell the property for $400,000 but owe $500,000. It’s called a short sale because the Bank agreed to the sale but is short $100,000 to be made whole. The Bank has two potential options. They can sue you for the 100k if they have what’s called “recourse”, which only occurs if the “short” loan was not a loan used to buy the property. OR, they can just cancel the debt, write it off on their books and pass the hot potato on to you.
In this example, if it’s your primary home and you qualify for the Mortgage Debt Relief Act, then you can claim exempt against the 1099 the Bank sends you for the $100,000 shortage. If it’s a rental property short sale, then you just write that 1099 income against your loss. Of course, I’m assuming you kept track of the rental property properly from an accounting standpoint. If you did, then you have a separate portion of your tax returns dedicated to each rental property as it’s own little business. Within that, you can deduct the loss on the sale against the 1099 income and it’s always going to be a wash.
The ONLY time you have something to worry about when you short sale a rental property is when you have a recourse loan. If you do, the Bank will have the option to sue you, get a judgment and garnish your wages 25% until they are paid in full with interest, penalties, and fees included. If the loan is non-recourse, meaning you got the loan when you originally purchased the property, then the only option for the Bank is to cancel the debt, which means you’re goo-to-go if you have properly reported your rental property on your tax returns.
The other thing to consider when you want to short sale a rental property is how the loan was originated. If you bought it as a primary residence originally and didn’t refinance, then the Mortgage Debt Relief Act would still apply regardless of how you’ve kept the books. The only factor for the Mortgage Debt Relief Act to determine occupancy qualification is the occupancy status from the original loan paperwork.
If you need help or have questions about this, email me below and I’ll help any way I can. Another great contact is our Bank Negotiator Bekah Stone who can be reached at 760.815.0861
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