Answer: I've seen real estate agents try to push short sales as a cure all to avoid bankruptcy. Quite frankly, the answer just isn't that simple. A short sale should only be considered after weighing all of your options, including bankruptcy and foreclosure.
A short sale is where the the lender takes less money than is actually owed because it may be a better alternative for the lender than a foreclosure sale in a down market. Before allowing a short sale a lender will want to see how such a deal can be structured. Perhaps the borrower has other assets, or perhaps the short-fall can be made up with a note to the lender.
If the lender forgives a portion of the debt, debt forgiveness over $600 must be reported to the IRS as income to the borrower -- money not actually received by the borrower, but money that is taxable. On the other hand, debt forgiveness received in bankruptcy is not taxable.
A successful short sale gives the homeowner some control over their destiny. The homeowner may be able to avoid bankruptcy and a foreclosure on their credit rating with a successful sale. However, short sales are often time consuming and difficult to negotiate.
One factor that real estate agents often do not consider is the total debt picture of the homeowner. While a short sale may resolve the issue of escalating mortgage payments, the homeowner may have other debts that need to be dealt with in a bankruptcy. Preventing a short sale won't do much good to protect a consumer's credit rating if a bankruptcy becomes necessary at a later date.
Every situation is different, but I see many clients who who cannot afford their mortgage payments and they usually have other debt problems. Sometimes paralyzed with fear, the do not know which way to turn. In many cases, their best option is to file for Chapter 7 to get out from under all of their debt problems and avoid the potential tax problems with a short sale and letting the bank take the property back in a foreclosure.
The only way to determine what is best for your situation is to seek the advice of a competent attorney and a tax professional. Short sales are not a magic solution that some proponents make them out to be and you must look at your global decision before deciding which course of action to take.
About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.