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Short sale in a divorce: overview

As a Chicago divorce lawyer, I can tell you that even for those in an uncontested divorce in Illinois, what to do about the  house is often a problem. One possibility may be a short-sale. 

What is a short sale?

A short sale is when the proceeds from the sale of a home are less than the balance of the mortgage on the home, and where the bank allows the home to be sold by releases their lien on the home and to accept the sale price of the home (despite it not covering the balance of the mortgage).

While the bank may receive the funds from the sale of the home, it can still go after the home owner for a deficiency – the difference between what the home sold for, and the balance on the loan.

A short sale is often used as an alternative to foreclosure because it mitigates additional fees and costs to both the creditor and borrower. While credit is also typically damaged much less than from a foreclosure, both often result in a negative credit report against the property owner.

Does debt remain after short sale?

Issue number one for a homeowner involved in a short sale is whether the bank will go after them for the deficiency. In other words, will the bank make the homeowner pay the difference between the homes sale price and the balance of the loan?

Banks like it when money they loan is repaid. So a bank may very well go after a deficiency in a short sale situation.

Tax consequences of a short sale

Even if a bank agrees to allow a short sale, and agrees to forgive the deficiency, there are additional concerns. The IRS will tax forgiven debts as  income. That means the former homeowner will have to pay taxes on the amount of the forgiven debt.

However, there are exceptions. The Mortgage Relief Act of 2009 extended an excepted forgiven debt from taxation so long as it was used to purchase, build, or improve the debtor’s primary residence.  On the other hand, if the debt that was forgiven was from a home equity loan, and the loan was used something other than to purchase, build or improve a home (such as funding a vacation), then the forgiven debt would still be taxable.

Handling a divorce with a short sale

I am not a CPA, or a tax expert, and I don’t give tax advice. However, I am a Chicago divorce attorney who works with tax professional when necessary. Further, should a divorce involve a short sale, my objective would be to appropriately guard my client’s interest in avoiding unnecessary tax penalties.  I also work with Chicago business lawyer Rhonda Stuart who is experienced in handling complex short sales.

If are not quite sure about how to handle your home in a divorce, consider reading my article “Uncontested Divorce & Marital Settlement Agreements: The Home.”

Feel free to contact me to chat about your Illinois family law issue.

About the author: Contact Illinois family law attorney David Wolkowitz at 312-554-5433 or online. He is a family law and divorce attorney serving Chicago and the Counties of Cook, Champaign, DuPage, Kane, Kendall, Lake, McHenry, and Will. Areas of practice include divorce, uncontested divorce, child custody, visitation, spousal maintenance, child support, and the Uniform Child Custody Jurisdiction & Enforcement Act (the “UCCJEA”).