Foreclosure and Short Sales

Owning a home is a major financial obligation, and sometimes it becomes too much. Foreclosures, short sales, and cancelled mortgage debt can be confusing and overwhelming. Here are the differences, and how they can affect you. 

First, if your home is foreclosed or you voluntarily give up the property, the remaining balance on the mortgage debt is considered a sale by the IRS. If you sell your home for less than what is due on the mortgage, you are considered “underwater,” and it's called a “short sale.” 

This is not, however, what’s known as a “cancelled debt.” A cancelled debt is the difference between your home’s current Fair Market Value (FMV) and what you owe on your mortgage. The good news is that the Mortgage Debt Relief Act (2007 through 2020) and the Consolidated Appropriations Act (CAA) (through 2025) exclude as income any debt discharge on your primary residence up to $2 million under the Mortgage Debt Relief Act and up to $750,000 under the CAA. 

Foreclosure 

This is where the mortgage holder repossesses the home due to the homeowner’s failure to keep up with the mortgage payments. Though this process normally begins after several months of nonpayment, each mortgage and lender is different. 

As an alternative to getting foreclosed upon, you may opt to voluntarily return the home to the lender. This process simply means you sign the property back over to the mortgage holder. While returning a home and a foreclosure both affect your credit rating, returning a home will not leave a foreclosure on your credit report, while foreclosure will stay there for up to seven years. 

However the home gets back in the hands of the lender, the IRS considers that a sale happened. You must calculate whether you took a gain or loss. If you take a loss – the debt exceeds fair market value – you have a cancelled debt. 

Short Sale 

If you owe more on your home than it's worth now, your home is considered “underwater,” sometimes euphemistically called “negative equity.” If you sell your home for less than your remaining mortgage balance, you have cancelled debt. 

If you're facing foreclosure, you may qualify for a short sale of your home. Though not ideal, it's still better than a foreclosure.