Can You Short Sell an Investment Property?

In real estate, a short sale is typically when a homeowner sells their property for less than they owe on the mortgage — usually in a tight financial situation. The same can be done with a financed investment property to avoid an impending foreclosure.

How To Short Sell An Investment Property

It’s possible to short sell your investment property; however, qualifications for a short sale depend on:

• Your lender
• The type of loan
• The type of property
• State laws
• Reason for the short sale

First and foremost, you must be considered insolvent by the lender. A short sale is at the discretion of the lender, as they are not required to do a short sale and have every legal right to foreclose on your investment property. You also need to find a buyer for your investment property.

Next, you need to prove to your lender that you cannot pay back what you owe on the mortgage and explain why you need to short sell your investment property. The lender will assess your financial situation and require:

• Comparable market analysis
• Proof of income
• Federal tax return
• Payroll stubs
• Bank statements
• Listing agreement
• Purchase contract
• Buyer’s proof of funds
• Estimated closing statement
  
  

Benefits Of Short Selling An Investment Property

The most obvious benefit to short selling your investment property is avoiding foreclosure. When a property is sold in foreclosure for less than the outstanding balance left on the mortgage, that difference is called a deficiency. 

In some states, a lender can sue the borrower to recover that loss. If the court is in favor of the lender, the lender is granted a deficiency judgment. With a deficiency judgment, the lender can collect the deficiency by collecting wages, freezing bank accounts, or placing liens on other property. With a full recourse loan, the lender can typically pursue all assets up to the full amount of the debt. 

Opting to short sell your investment property also means a foreclosure or bankruptcy won’t be on your credit report. The hit to your credit without a deficiency judgment may also be somewhat less than with a foreclosure. 

Potential Consequences Of Short Selling Investment Property

As already discussed, the lender may pursue a deficiency judgment, in which case, it’s highly advised to seek help from a legal professional. 

There are also potential tax consequences when you short sell an investment property. The IRS treats forgiven debts as taxable income, which is subject to regular income tax. Additionally, you won’t be able to deduct any expenses involved in the short sale. This includes the difference between the purchase price and the sale price. You may also have to pay the 25% depreciation recapture tax if you owned the investment property for more than 11 years. 

Your credit will still take a hit; however, it may be less than with a foreclosure. The only thing that could be worse for your credit would be filing for bankruptcy. 

If you’re considering a short sale on your investment property, seek legal and tax advice before coming to a decision.