I am getting ready to file chapter 7 bk, and my house is currently on the market and I am trying to do a short sale. is it better to have it foreclosed or do a short sale. I have no intention ofa keeping the house b/c I can't afford payments, so I wanted to know how to include the definciency so I am not taxed on it?
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1. The lender (1st, 2nd etc) would have to agree to a short sale.
2. If they agree to a short sale, the difference between what was owed and what you pay the bank at time of sale would be counted as income to you and you would get a 1099. However, if you can show you are insolvent by IRS Standards (I believe the form you use is IRS Form 982), then you won't have to pay taxes on that difference. The income tax liability could not be discharged in your planned chapter 7 because it is too recent.
3. For purposes of credit reporting issues...a short sale is a better way to go. But if you go the foreclosure route, it's possible you could be liable for a deficiency balance (the rules vary from state to state regarding whether a mortgage lender can pursue a deficiency, but most states do allow deficiency balances to be charged to the debtor in some circumstances.) But a deficiency balance becomes a general unsecured debt and can be discharged in BK without hassle.
The catch with foreclosure is that you could still have income tax liability if the bank is unable to sell the house for the amount owed. But again, you would need to address that with Form 982 and declare yourself insolvent. What I am not entirely sure about is whether you have income tax liability on a discharged deficiency.
Ideally, a short sale is the way to go, but the catch is, the bank has to agree to accept the short sale.
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