Short Sale Laws and Lawsuits

A short sale is a negotiated settlement between a lender and a borrower whereby the lender agrees to accept less than what is actually owed on the loan. 

Short Sale Laws

Generally, each lender has its own rules and procedures governing short sales.  However, because of the rising number of short sale applications and the delays in lender response, California recently passed legislation which requires lenders to respond to short sale applications within 21 days of receipt of a complete short sale package.  Under the California law, if the short sale package includes an estimated HUD-1, lenders have only 4 days to accept or reject  a short sale application.  Whether other states will follow California's lead in passing similar legislation remains to be seen.

In 2007, the federal government passed a short sale forgiveness law known as the Mortgage Forgiveness Debt Relief Act of 2007.  Under this law, mortgage debt forgiven between January 1, 2007 and December 31, 2012 may be excluded from income as long as the debt was incurred to buy, build or improve a principal residence.  California enacted a similar short sale forgiveness law in October, 2008.

Debt forgiven as a result of a loan modification may qualify under the federal short sale forgiveness law.  Additionally if a transfer of ownership occurred as a result of a foreclosure or a deed in lieu of foreclosure, debt forgiven as a result of the transfer also may qualify under the federal short sale forgiveness law.  Unfortunately, debt forgiven on commercial real estate, second homes, and investment property is phantom income and must be included on a taxpayer's income.

Short Sale Lawsuits

As the number of short sales has increased, so has the number of  short sale lawsuits being filed.  The most common short sale lawsuits are:

• Real Estate Malpractice (as a result of the real estate agent's negligence and misrepresentations); 
• Breach of Contract (as a result of the borrower's failure to abide by the terms of the Note he signed as a condition of the lender's approval of the short sale); and
• For a Deficiency Judgment.

Getting Legal Help

Before you sign a short sale agreement with your lender, you should have it reviewed by a qualified real estate attorney.  You should also seek advice from a tax attorney or certified public accountant to determine the tax implications of the transaction.  Getting tax advice is especially important if a short sale in your property may result in taxable phantom income.