A short sale or deed in lieu may help you avoid foreclosure. Many homeowners in both Oregon and Washington facing foreclosure find that they just can’t afford to stay in their home. If you plan to give up your home but want to avoid the negative effects that a foreclosure will cause on your credit score, you may want to consider a short sale. The general thinking is that your credit won’t suffer as much as it would were you to let the foreclosure simply proceed.
What are the drawbacks? You’ve got to have a bona fide offer from a buyer before you can find out whether or not the lender will go along with it. In markets like those found in Portland, Salem, Vancouver and pretty much every where else in both Oregon and Washington, qualified buyers are hard to find. The short sale process then can be frustrating because you won’t know in advance what the lender is willing to settle for.
If you have a second or third mortgage, those lenders must also agree to the short sale. Unfortunately, this is often impossible since those lenders won’t stand to gain anything from the short sale.
Much has been made of the tax consequences arising from a short sale. A short sale may, at least in theory, deliver a nasty surprise: Taxable income based on the amount the sale proceeds are short of what you owe (again, called the “deficiency”). The IRS treats forgiven debt as taxable income. Thankfully, for debtors in Washington and Oregon who are on the cusp of bankruptcy, there is the insolvency exception to tax liability.
Legal insolvency occurs when your total debts are greater than the value of your total assets (your assets are the equity in your real estate and personal property). To use the insolvency exclusion, you may have to prove to the satisfaction of the IRS that your debts exceeded the value of your assets. For most of our clients in Oregon and Washington, this is not a particularly difficult burden to meet.