Legal Question in Real Estate Law in California

A short sale is where the bank agrees that if you sell the house for a certain amount they will cancel any debt you owe them in return for all net funds from the sale of the property going to the bank. Since it is a rental property, from the IRS's viewpoint, there may be capital gains tax to pay and the recapture of any depreciation taken. You need to find out the tax consequences before you do anything.

I am sorry to say that the question of whether or not deficiency exposure exists for your husband is not one that is capable of being answered on this forum. You need to meet with a qualified real estate attorney in your area, review all of the facts (is this a purchase money loan, are there more than one loan secured by the property, are the loans cross-collateralized) and only then can someone properly opine as to the existence of a deficiency or not.

I can, however, tell you that a short-sale is a voluntary agreement on the part of the bank to accept less-than what is owed on the loan to let the property be sold. That does not, however, mean that they automatically, or by law give-up the right to pursue a deficiency. In fact, if you do nothing in a short-sale but pay the bank less-than the loan balance, the default situation is that you still owe them the short. You have to actually negotiate into your short-sale approval their waiver or foregiveness of the balance of the debt, or they maintain the right to collect the short. Unlike a foreclosure in which the right to pursue you for a deficiency MAY be extinguished by operation of law (and again, as stated above, you need specific legal advice after a review of your personal financial situation to determine if there is going to be a post-foreclosure deficiency), in a short-sale, there is no impairment of the lender's right to collect the balance of the loan (the short).

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A short sale is a private, virtually unregulated deal between two or three parties: the lender, a buyer and a borrower/seller. Occasionally the lender is also the buyer, in which case the deal is usually called a "deed in lieu of foreclosure." As a private contract, it is outside most of the laws regulating foreclosures and deficiencies. You get what you negotiate. Try to get a contract that says the short sale is a full and final settlement between borrower and lender, or words to that effect. At least get a deal that makes no mention of further obligations, additional payments, deficiencies, or words to that effect. The original theory of a short sale was to compromise the debt, but we hear more and more of lenders trying for another bite at the apple by inserting a clause somehow allowing the lender to continue to have some post-sale rights.

Mr. Whipple is accurate. At this point, people doing short sales are negotiating for the bank to waive deficiencies in the paperwork. Absent a contractual waiver of a deficiency, there is nothing that can stop a bank from seeking a deficiency later, because a short sale is not a foreclosure, and thus the deficiency protection of Code of Civil Procedure section 580d is inapplicable. Arguably, an attorney could try to argue that Code of Civil Procedure section 580b is applicable, assuming that it was a purchase money mortgage, but as of yet, no appellate court has decided any case that states that section 580b does or does not apply to the short sale situation.