From Inside the Vault...

I've had several clients engage me to help them with their commercial real estate projects.  Many real estate owners are looking for business banking advice regarding short sales and deeds in lieu of foreclosure.  While I'm not an attorney, there are some practical points that we can discuss.

Some real estate owners are facing foreclosure because the economics of their projects have changed dramatically.  Since they can no longer afford to own the project, they are considering a short sale or a deed in lieu of foreclosure.  These options allow you to potentially walk away from your property without incurring liability for a deficiency.  

In a short sale, you get permission from the lender to sell the property for an amount that will not cover the loan.  (The sale price falls "short" of the amount you owe the lender).  In most instances, you have signed a personal guaranty that states you will cover the lender for any deficiency that results from the sale of the property.  So, this strategy only works if the lender will release you from the personal guaranty.  The main benefit of a short sale is that you get out from under your mortgage without liability for the deficiency. You also avoid having a foreclosure or a bankruptcy on your credit record. The main drawback in a short sale is that you have an offer from a willing buyer before you know if the lender is willing to go along with it.  In this case, you won't know what the lender might be willing to settle for.

Also, beware of the tax consequences of a short sale.  A short sale may create taxable income.  The IRS treats debt forgiveness as taxable income.  So, the deficiency between the sales price and the loan balance is considered debt forgiveness therefore taxable income to you.  However, there are some exceptions so consult your CPA for further information. 

With a deed in lieu of foreclosure, you give your property to the lender in exchange for the lender canceling the loan, suspending any foreclosure proceedings and agreeing not to pursue a deficiency. You would want this agreement with the lender in writing.  Many believe that a deed in lieu looks better on your credit report than does a foreclosure or a bankruptcy.  Also, sometimes the lender will take responsibility for selling the property rather than you selling it.

It may be difficult to get your lender to accept a deed in lieu especially in this market.  Many lenders have taken so many properties that they will only take cash instead of real estate.  Also, a deed in lieu could generate debt forgiveness like the short sale.  You would want to consult with your CPA on the specifics.

 

Before you begin negotiations with your bank, you may want to consult with your attorney on all the aspects of these two scenarios.