The "Real Estate" Short Sale

Most investors are familiar with the concept of selling a stock short. That is, when an investor believes a stock price is going lower. Let's say the stock in question is currently selling for $50 per share. The investor can instruct his or her broker to borrow the shares so they can be sold. The borrowed shares are then sold for $50, and the investor's account is credited for that dollar amount. If the investor is correct and the stock moves lower, say to $40, the investor instructs the broker to purchase these shares at $40 to replace the shares that were borrowed. The net results of this short sale is a profit of $10 per share.

A real estate short sale is nothing like the stock short sale. Let's use this example. Homeowner A has a home mortgage with Bank ABC for $400,000. Due to the real estate debacle, the home is only worth $200,000. To say the least, our homeowner is deeply underwater. Also, our homeowner can not afford this house and must sell it or have Bank ABC foreclose on the home. The homeowner does not want the bank to foreclose on the home, because that would have dire consequences to the homeowner's credit score. Therefore, enter potential Buyer XYZ who makes a $200,000 offer on the home. Homeowner A goes to Bank ABC, presents the offer and requests that the bank forgive the remainder of the outstanding loan amount ($200,000). The homeowner's rationale to the bank is that the amount is what the bank would be able to receive if it foreclosed and sold it themselves. The bank agrees and accepts the "short sale." Homeowner A is happy with the transaction, because the bank has forgiven the remaining balance of the loan. In addition, the homeowner's credit score does not suffer. Everyone is happy, especially Homeowner A. However, Homeowner A is going to be in for a shock when the 1099's come out. Why? Homeowner A will receive a 1099 for $200,000, which is a shock of all shocks! How come? In effect, the bank gave our homeowner $200,000 to pay off the balance of the loan. That is the reason for the 1099, which I would surmise not many homeowners realize.