Short Sale after Chapter 7 Bankruptcy, Good Idea or Bad?

Short sale

Many clients who come to us for assistance with filing a bankruptcy case ask if they can still short sale their home after their Chapter 7 is over. The answer is typically “yes,” but the better question is whether it is a good idea to do so. The first step is to understand how the bankruptcy process works.

In a Chapter 7 filing, your mortgage loan is a secured debt. Unless you reaffirm this debt, then it is discharged or eliminated. The creditor still has the lien on your home and the right to seek bankruptcy court permission to foreclose on it, but you are not liable to pay any deficiency balance. Thus, there are very few reasons for you to work on a short sale that does not benefit you if you already have the ability to walk away from the debt without any financial repercussions.

Additionally, Section 108 of the Tax Code does not exempt debt-forgiveness on a primary residence from taxable income, though it does exempt debt discharged under the bankruptcy code. In other words, if you have debt forgiven after a short sale, that amount can be considered taxable income. However, if that same amount is forgiven in a bankruptcy filing, it is not taxable.

While the tax code is clear that the discharge supersedes the debt forgiveness and therefore is non-taxable, it confuses the IRS. This can lead to years of you being audited and having to attempt to explain the debt being discharged to IRS agents who do not understand how the process works. It can be a huge hassle, involve lots of paperwork, and never get resolved.
If you have questions regarding Chapter 7 bankruptcy and/or short sales, let us help. Call the knowledgeable attorneys at Faro & Crowder to schedule a free consultation.


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