Most of you were aware, even before the National Bureau of Economic Research made it official, that the U.S. has been in a recession since December, 2007. There have been many signs of a recession, including the number of job losses, as well as the rising number of foreclosures. A foreclosure is the process by which a bank exercises its rights under a note and mortgage which results in the sale of the home to either the bank or to a third party. In addition to losing their home, a foreclosure may result in the homeowners having to repay the portion of their loan which was not paid off as a result of the foreclosure sale. As an example, if a homeowner owes $200,000 on the loan and the home is sold for $150,000 after the foreclosure, the home owners usually must pay the outstanding balance of $50,000.

An option available to a homeowner facing foreclosure is a "short sale." A short sale occurs before the foreclosure is finalized; it is a sale by the homeowner to a third party. As part of the short sale, the bank will agree to accept an amount less than the existing balance on the loan in exchange for removing the mortgage, and thus relieving the current homeowner of their obligation to pay any remaining balance of the loan. A bank may be willing to agree to a short sale because the proceeds it would receive under the short sale are larger than the proceeds which it may receive under a foreclosure. Also, the bank would avoid the lengthy foreclosure process during which additional costs are incurred.

The short sale may be a better solution for the homeowner because they are able to satisfy the loan using only the proceeds of the short sale, and are usually not required to make any additional payments to the financial institution. A possible result of the short sale, however, is that the homeowner, because a portion of the debt is being forgiven by the bank, may have to report discharge of indebtedness income on their personal tax return. Under the current tax law, if a financial institution or another individual to whom you owe money forgives a portion of that debt, the amount forgiven is treated as income and must be reported on the debtor's income tax return. Because of this, a home owner must be aware of all the tax implications involved in the short sale; however, it still often makes sense to complete the short sale and accept the tax implications.

The bank, in reviewing the proposed short sale, is permitted to act like a typical homeowner in that it can negotiate the price with the buyer. The bank is not required to accept an offered price in the short sale, and may wish to negotiate with the buyer to receive additional funds. The good news for the buyer is that, if the bank does not accept its proposal, the buyer is under no obligation to increase the offered purchase price. Another benefit to the buyer is that as part of a short sale, the buyer may be permitted to have the property inspected, an option which may not be available if a buyer is purchasing a home as part of a foreclosure.

As a buyer in a short sale, it is important to make sure that there are no additional liens, such as a second mortgage, tax lien, or unpaid water and sewer bills, which will become the buyer's obligation upon purchase. It is important for both the buyer and seller involved in a short sale to have appropriate representatives who can advise them of the implications involved in the short sale. This may include a realtor, accountant, and a lawyer who is also a title insurance agent or otherwise well versed in real estate transactions. Seeking the advice of these individuals prior to selling the home and/or putting an offer in may help both individuals navigate the process more successfully.

The advice in this column is general in nature. Consult your attorney for legal guidance to fit your particular situation.

James C. Kovaleski, Esquire and Joseph K. Koury, Esquire are each licensed to practice in the Commonwealth of Pennsylvania and are associated with the law firm of O'Donnell, Weiss & Mattei, P.C., 41 High Street, Pottstown, and 347 Bridge Street, Phoenixville,610-323-2800, www.owmlaw.com.