When discussing a short sale, many homeowners don’t realize that the state they live in may have a lot to do with how successful they are discharging their debt. Many assume a short sale automatically wipes the slate clean, but this has to be explicitly spelled out in the short sale agreement. There are some states that make it easier than others.
Some states are called deficiency judgment states, and these allow lenders to pursue the full deficiency amount after a short sale has been completed. So, if you short sale your home for $83,000 less than you owed, the bank could, in theory, still come after you for that balance that is not satisfied by the sale. This is why it is so important to have an experienced short sale specialist on your side to make sure the bank agrees to forgive the debt!
Even if the debt is forgiven, the IRS can claim the debt forgiveness as a line in the credit column and force you to pay taxes on the forgiven amount. However, there is recourse to this if you live in a “non-recourse” state. These states have passed laws that expressly prohibit lenders from pursuing deficiency judgments against former homeowners.
Currently, there are 12 non-resource states, including California, Arizona, Alaska, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. In these states, short sale home sellers are also exempt from paying taxes on the forgiven debt. So, if you live in a non-resource state, a short sale is even more attractive!
If you live in a deficiency judgment state, you can still pursue a short sale agreement. Just make sure you have a registered short sale specialist who understands how to negotiate debt forgiveness, and a tax attorney to help you navigate any possible tax liability. A short sale is still the best way for you to get out of an upside down mortgage and start over with a level playing field!