Short Sales as an Alternative to Bankruptcy
We’re now in 2018, and many properties have regained market value since the financial crisis of 2008, which caused a short sale boom. However, in the Chicago area, many properties continue to be underwater, meaning that their market values are less than the balance owed to the mortgage lienholders. So, while not a prevalent as they were several years back, short sales are still a thing in 2018.
Recently, we have had several property owners, being unfamiliar with short sales, call about filing for Chapter 7 or Chapter 13 bankruptcy. During the course of our phone interview, which we always conduct as our first step, we determined that the sole reason for the potential clients considering bankruptcy was due to their one property which the clients no longer desired to retain. In this situation, bankruptcy should not be the first option.
Take, for instance, a recent phone call from a client who we’ll refer to here as Joe. Joe owns a 2-flat property in Chicago, which used to be his primary residence. But recently, he moved out, because the property was falling into disrepair, and Joe can’t afford to make the renovations. Joe had accepted a new job in Indiana, and needed to be closer to work. Joe has a mortgage on the property with a balance of $340,000, which is more than $80,000 over the current value of the real estate in its current condition. The property is in foreclosure. Joe does not like to use credit cards and has very little other debt besides the mortgage.
My recommendation to Joe was hold off on bankruptcy and to try a short sale. Because a short sale has the potential to solve nearly every problem that Joe has. In nearly every successful short sale, the client receives a release from the mortgage company and no longer owes the mortgage debt. And when the mortgage debt is the only problem, a successful short sale can render bankruptcy as unnecessary.
Our philosophy with regard to bankruptcy is that it should always be a last resort. If there is an alternative that could solve the problem, we normally counsel our clients to try the non-bankruptcy solution first. This is due to the impact bankruptcy has on the client’s credit score, the client’s ability to borrow in the future, and due to how it affects the client’s standing with potential landlords.
In fact, while bankruptcy, on its own, could eliminate the debt that Joe owes to his mortgage lender, it would not remove the title of the property from Joe’s name. So Joe would still be responsible for the upkeep and insurance on the property. The longer Joe owns the property, the more exposure he has to City of Chicago building violations, which the City aggressively enforces.
The only downside of doing a short sale without bankruptcy is the possibility of debt cancellation income. When the mortgage lender cancels debt as part of the short sale process, IRS may treat the difference between the amount of mortgage debt, and the lower sales price, as income to the client. While filing for Chapter 7 bankruptcy in conjunction with the short sale would eliminate this problem, depending on the amount of cancellation income, it is our view that having to pay some additional tax COULD BE ok if it means that our client gets to avoid bankruptcy.
If you have questions about this article, or you’d like to know whether a short sale or bankruptcy is the right solution for your financial problem, we invite you to call us for a thorough consultation. We partner with real estate brokers who are familiar with the short sale process and can provide an appropriate referral. We’ll take care of the legal work.