A short sale is one way to deal with mortgage and home foreclosure problems. For distressed homeowners, it's simply another option that may or may not be recommended. It depends on the situation.
For many homeowners struggling to make payments, the Mortgage Debt Forgiveness Act provides a way toward a short sale, but the Act is about to expire.
That means homeowners will be on the hook for the value (in taxes) of the amount of mortgage that was forgiven in the short sale.
What's a short sale?
A short sale is a real estate transaction in which the homeowner sells the home for less than what's owed on the mortgage and the bank agrees not to come after the homeowner for the mortgage deficiency.
It is, in theory, a win-win, as the bank doesn't have to hold on to the real estate and the homeowner can get out from under an underwater property.
But it's a lot less attractive without the Mortgage Debt Forgiveness Act.
What's the Mortgage Debt Forgiveness Act?
This law was passed in the wake of the Great Recession.
The mortgage deficiency - the amount of the mortgage still owed that the bank hopefully agrees to "absorb" in a short sale - is normally counted as taxable, which means that ex-homeowners would be on the hook for a giant amount of "income" that came in the form of a forgiven debt.
But under the Mortgage Debt Forgiveness Act, the ex-homeowner doesn't need to pay taxes on it.
However, the Act is set to expire at the end of the year. If it isn't extended, homeowners doing short sales could see their taxes jump up considerably. And, given the depressed real estate market, in which short sales are generally much better for both parties than foreclosures, the Act's expiration could be a very bad thing.