Dirty deeds sold dirt cheap | Foreclosure vs Short sale

Written by Anthony Garcia   // July 15, 2011   // 6 Comments

Dirty deed

As a former real estate agent with friends who find themselves unable to pay on their mortgages, I am frequently asked what if any alternatives there are to foreclosure. There are two alternatives to foreclosure, Deed in lieu of foreclosure and Short sale. Because a foreclosure is so devastating to a consumer’s credit score, almost anything is better than going through a foreclosure, and both of these alternative options result in a lighter impact on your credit score. Considering the situation most homeowners find themselves in today needing some help with debt.

A Deed in lieu of foreclosure and a short sale are very similar, but there are some key differences that depend on the specifics of your situation. By comparing and contrasting both of these, one can determine which option is better, if they are made available to you by your lender.

Let’s first answer the question, what is a Deed in lieu of foreclosure? A Deed in lieu of foreclosure is an alternative to foreclosure offered by some lenders. In a Deed in lieu of foreclosure, the property owner gives the property via the deed, to the lender voluntarily in exchange for the lender canceling the loan. The item exchanged in the transfer is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any proceedings already underway in the process. The lender has at his discretion, the power to forgive any remaining balance that result from the sale of the property. This remaining balance, which is the difference between the amounts owed minus the amount sold for, is known as a deficiency balance.

A huge side effect to a Deed in lieu of foreclosure, is the possible forgiveness of the deficiency balance. Under federal law, a lender is required to file a 1099C with the Internal Revenue Service whenever it forgives a loan balance greater than $600. This may in fact create a tax problem for the former property owner. The IRS considers this forgiven balance as taxable income. However, the Mortgage Debt Relief Act provides some tax relief for consumers with loans forgiven in the years 2007 through 2012, and provide help with debt. Always consult with a tax professional when dealing with the IRS, as my debated expertise lies solely with mediocre fish tacos, their preparation, and consumption as a competitive sport.

The point to remember in a Deed in lieu of foreclosure is whether the lender is willing to forgive the deficiency balance. Always read the contract carefully to determine how the balance issue is to be resolved. If the contract is vague, take it to an attorney with experience in property law. Most lawyers are very expensive, but compared with the possibility of signing an agreement you do not understand could be worth the cost.

The next option for consideration is a short sale in which the lender agrees to discount a loan balance. The home owner sells the mortgaged property for less than the outstanding balance of the loan, and the lender agrees to accept less than the balance owed on the mortgage at sale. The deficiency balance is forgiven, typically. Unlike a Deed in lieu of foreclosure, the ownership of the property is not transferred to the lender and remains with the owner. Some lenders choose Short sales because they do not want to own the distressed property. They would rather see the owner sell the property and lose the deficiency balance than be forced to take the property through foreclosure, as it is a costly and time-consuming process.

Whether the lender picks a Deed in lieu of foreclosure or a Short sale depends on how the lender weighs its risks and how state and local laws determine the outcome. Again, as mentioned before, the lender is required to file a 1099C with the IRS for any forgiven debt. Remember, the Mortgage Forgiveness Debt Relief Act offers former homeowners relief for forgiven debt.

The question then arises, what if the lender will not allow a short sale or a deed in lieu of foreclosure? Foreclosure auctions tend to bring significantly less money than a normal sale and could take quite a long time and you may still have to pay the balance even years after the transaction.  As with most of my humble advice, especially when dealing with huge amounts of debt, I urge you to consult with a bankruptcy attorney to fully understand all of the options in helping to resolve your mortgage debt. Keep researching and do not give up, remember what does not kill you only makes you stronger.


  1. By Mark Chen, February 23, 2019

    As you point out, 1099-Cs for forgiveness of mortgage debt are complicated. There are a lot of restricitons to the Mortgage Forgiveness Debt Relief Act (MFDRA). Even if you don’t meet the qualifying rules to use the MFDRA, you may be able to avoid declaring the income and paying the taxes for the amount listed on the 1099-C by using the IRS Form 982. The Form 982 applies to all kinds of debt forgiveness.

    Because forgiveness of debt issues are complicated, check with a tax professional to see if you are eligible to use the Form 982.

  2. By Money Hungry, February 23, 2019

    I am currently in the middle of paperwork for buying a house right now.. Hopefully I will never get into this rough spot but it is good to know the options one has when their life does not work out as they planned. Both options seem to have positives and negatives and each persons situation is different. You would just have to see what your bank is offering and which option will be a better solution for you. I am glad this article came out now, as I feel I am a little ahead of the game going in already knowing this. Thank you!

  3. By Tax-y Lady, February 23, 2019

    The advice to speak to a tax professional is sound advice. I will go one step farther in suggesting that you shouldn’t be waiting until tax season to speak to a tax professional about how this may affect you if you have this kind of situation- whether it is a foreclosure, deed in lieu, or short sale. As soon as you know any of the particulars, but even before the house changes hands, you can get solid advice from a tax planner/tax attorney who can run your expected situation and tell you how it might impact you, what documentation you will absolutely need come tax time, and may be able to suggest ways to limit the impact on your taxes and/or on your life.

  4. By dolrdolrbill, February 23, 2019

    This post is very relevant in today’s economy with so many homes under water. Options are a key part of finding what is best suitable for a specific situation. Once you fall into a position where you cannot afford the home, are there time frames for completing these options before foreclosure? Also, is a loan modification another option that you would recommend when working with your lender?

  5. By Ka$h, February 23, 2019

    Thanks for the article! Knowing your options is greatly beneficial. Everyone is always so quick to say BANKRUPTCY not realizing that there are other ways out of their situation. I definitely agree with Money Hungry that each persons situation is different. However being informed of all options helps you choose which is best for you! Thanks again for keeping your readers informed!

  6. By flunkie, February 23, 2019

    I seem to see quite a few foreclosures and short sales in the market today. How is it that some major banks received a bailout, yet these same institutions refuse to pass this relief on to the consumer/their customers.
    As a frequent reader of this new blog-site, I was hoping perhaps some of your contributors would address this issue. An article or reply to this question would be greatly appreciated.

    Toni Falc.


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