If My Property Is In Foreclosure, Should I File Bankruptcy Or Do A Short Sale?

While a short sale (that is, a sale of real estate for less than the balance of the debt against the property) has some benefits, a bankruptcy case can offer more complete relief.  Among other things, a bankruptcy case will benefit the homeowner in the following ways:

1.    Immediately stop the foreclosure process.

2.    Automatically eliminate any tax liability arising from the cancellation of the balance of the mortgage and home equity line of credit (HELOC) against the home issued through a Form 1099, provided the case is filed before the foreclosure or short sale.

3.    Provide the homeowner with an additional opportunity to save the home through a loan modification, to stay in the home longer even if the homeowner intends to do a subsequent short sale or just surrender the property, or reinstate the mortgage through a repayment plan in Chapter 13.

4.    Cancel any other debts that the homeowner may have, including credit cards, medical bills, certain back taxes and other obligations.

5.    Provide the homeowner with a fresh start so that the person will have faster access to new credit faster, can purchase a new home in about two years, and stop the harassment by creditors.

A homeowner may still do a short sale during or after a bankruptcy case, free of the risk of incurring a 1099 tax liability.

Still, a short sale can be advantageous because it will operate to cancel the balances of the mortgages and HELOC without filing for bankruptcy, so long as the holders of the mortgages HELOC consent to the transaction.  The short sale option is attractive to people who have assets and wrongfully believe they will lose such assets in bankruptcy.  However, such people should be concerned about the tax consequences of a short sale, as they will probably have a liability on a Form 1099 for the cancellation of the balances on the mortgages and HELOC.  For that reason, holders of second mortgages or HELOC will often obstruct a short sale by demanding a pay off in a short sale.  If the two lenders cannot agree, the short sale may fall through and the first mortgage holder will foreclose, leaving the homeowner obligated on the underlying for the second mortgage or HELOC.  Rather than allow that to happen, the homeowner may file a bankruptcy case to encourage the lenders to come to terms so that the short sale may proceed.

For more information, please call our office at (831) 753-2200 or e-mail us at


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